Healthcare finance managers are tasked to find ways to reduce costs in their department for their
whole facility. They use cost accounting to determine how much services or supplies will cost, where
these costs are coming from, and how to pass costs along to patients. They must also find ways of
generating revenue from these costs. Indirect costs will be costs not directly related to patient care,
such as the cleaning services. Direct costs will be costs directly associated with patient care, such as
the use of the phlebotomy equipment and the techs running the labs. The finance manager of a
healthcare facility or department can allocate charges from a department that does not generate
revenue, such as the cleaning staff to a department that does generate revenue, such as the
phlebotomy lab.
Utilization rates will determine the patient volume in specific departments, affecting the amount of
revenue coming in. Take the Covid-19 pandemic for example. Since the pandemic, elective surgeries
that once filled operating rooms and generated lots of revenue have been greatly reduced because of
the number of covid-19 patients being seen. Even though hospitals are being reimbursed for Covid
care given, the decrease in utilization of elective surgeries has hurt physician practices and other
healthcare facilities financially. According to a report from HealthAffairs.org.
Healthcare financial managers use a variety of financial resources and cost classifications in
determining patient charges through the allocation of direct and indirect costs. Direct costs can be
referred to as expenses that go into producing goods or providing services. Indirect costs are referred
to as overhead and some examples could be rent or utilities. A few methods that financial managers
can employ are activity-based costing (ABC), time-driven activity-based costing (TDABC),
performance-focused activity-based costing (PFABC) and ratio of cost to charges (RCCs). ABC
helps to identify necessary activities and resources needed in producing output and overhead is then
allocated to different activities using cost drivers. TDABC is similar to ABC but instead time is used
as the only cost driver. In some cases this can be simpler to implement than the ABC, this approach
doesn't always reflect all of the indirect costs. PFABC is also similar to the ABC, but it allows for the
resources of various activities to be reviewed by different means and isn’t influenced by one cost
driver like the TDABC is. It is also a very useful way to determine an activities performance and
efficiency as well. The RCC allows for hospitals to compare Medicare Cost Reports with the total
charges of different departments to form a cost to charges ratio. This method, however, isn’t typically
very accurate due to the Medicare cost reporting process, in which it may encourage hospitals to
distort their costs. These different methods of cost classifications each have their own pros and cons,
but can each be effective ways to help healthcare organizations allocate direct and indirect costs
regarding patient charges. (Carol & Lord, 2016).
Healthcare utilization can be defined as the use of services by individuals for the purpose of the
promotion of well-being within the healthcare system. An individual’s well-being and the need for
health services are major factors for healthcare utilization. Primarily, need is the factor that drives
healthcare utilization the most, but there are other factors that come into play. Factors such as
geography, poverty, sex, and disability status can have an impact of whether services can be obtained.
Therefore, utilization rates can be directly tied to volumes and revenue generation. Some examples
can include whether an individual is insured or has access to transportation to access healthcare.
Typically, the less volume of patients within a healthcare organization, the less revenue generation
and vice versa (National Academies of Science, 2018).
Healthcare financial managers determine appropriate charges for patient care and services by
allocating indirect to direct costs through cost classifications and financial resources. According to
Nowicki (2022), costs that can be directly traced to a provided service, equipment, or department are
called direct costs. In contrast, indirect costs cannot be traced and are called overhead costs (Nowicki,
2022). Direct costs, such as nursing care and supplies, are less complex to assign to patient charges
than indirect costs, such as heating and cooling, and the indirect costs are not charged to the patient.
Healthcare financial managers assign the indirect costs to departments that provide patient services,
such as radiology and physical therapy, so patients are only charged for the services used (Nowicki,
2022). Financial managers have multiple cost allocation methods that increase complexity and
fairness, and financial resources are required to allocate costs efficiently and effectively. As
applicable, organizational charts identify each department's cost and revenue center.
Cost allocation methods that include multiple allocations within the first step provide the fairest
charge to the patient. The easiest method involves taking the costs from departments that do not
create revenue and distributing it to departments that create revenue (Nowicki, 2022). This method is
called direct apportionment. Third-party payers disapprove of this method as it can lead to unfair
distribution of costs from non-revenue departments providing work for other non-revenue
departments (Nowicki, 2022). The second method, step-down apportionment, offers a correction to
the disadvantage of direct apportionment. In this method, all costs from non-revenue departments are
distributed to other non-revenue departments; then, the costs are reallocated to departments that
charge patients. Double apportionment is the method that involves all costs being allocated from non-
revenue departments to other non-revenue departments while allocating costs from revenue-
generating departments to other revenue-generating departments. Then the costs are reallocated to
departments that charge patients. Double apportionment considers value and is considered the most
practical method (Nowicki, 2022). The most accurate method is multiple apportionments, which
involve multiple, simultaneous distributions of costs in the first step before reallocating costs to
departments that charge patients.
According to Carroll & Lord (2016), traditional costing allocates indirect costs through pre-
determined rates and is generally inaccurate. Activity-based costing allocates indirect costs to
identified activities and resources (Carroll & Lord, 2016). This costing method is commonly used and
is considered most accurate if updated regularly. Time-driven activity-based costing is similar to
activity-based costing, but it uses time as the activity measure (Carroll & Lord, 2016). This method
may be more beneficial to smaller organizations. Performance-focused activity-based costing is
different from the other activity-based costing methods. The activity measurements for performance-
based costing are determined through utilization and other performance assessments (Carroll & Lord,
2016). Unique to the healthcare industry and outdated is the ratio of cost to charges. This method
determines the cost related to its charge (Nowicki, 2022). Organizations have multiple options to
allocate indirect costs and determine patient charge amounts. Financial managers must choose the
most appropriate methods for healthcare organizations.
Utilization and volume play a vital role in generating revenue. According to Dexter et al. (2001),
hospitals with high utilization of resources that encounter an increase in volume of patients
experience an additional need to increase utilization leading to a decrease in revenue. The utilization
of resources must meet the volume demand to generate revenue to cover expenses and meet
reimbursement requirements.
References
Carroll, N., & Lord, J. C. (2016). The Growing Importance of Cost Accounting for Hospitals. Journal
of health care finance, 43(2), 172-185. https://www.ncbi.nlm.nih.gov/pmc/articles/PMC6910125/
Dexter, F., Macario, A., & Lubarsky, D. A. (2001). The impact on revenue of increasing patient
volume at surgical suites with relatively high operating room utilization. Anesthesia & Analgesia,
92(5), 1215-1221. https://doi.org/10.1097/00000539-200105000-00025
Nowicki, M. (2022). Introduction to the financial management of healthcare organizations (8th ed.).
Gateway to Healthcare Management.
Carol, N., & Lord, J. C. (2016). The growing importance of cost accounting for hospitals. Journal of
Healthcare Finance, 43(2). 172-185. https://www.ncbi.nlm.nih.gov/pmc/articles/PMC6910125/
National Academies of Science. 2018. Health-Care utilization as a proxy in disability determination,
factors that affect health-care utilization. https://www.ncbi.nlm.nih.gov/books/NBK500097/
Hospitals are also suffering economically from the loss of admissions and outpatient procedures,
though the CARES act provided significant support. Like physician practices, they report significant
economic hardship and are furloughing some workers” (Chernew, 2020)
Revenue should increase when utilization of elective surgeries and more outpatient services resume.
Michael Nowicki. (2022). Introduction to the Financial Management of Healthcare Organizations,
Eighth Edition: Vol. Eighth edition. Gateway to Healthcare Management.
Chernew, M. F. (2020, July 6). COVID-19 Effects On Care Volumes: What They Might Mean And
How We Might Respond. Retrieved from Health Affairs:
https://www.healthaffairs.org/do/10.1377/forefront.20200702.788062/full/
