FORMULATING AND MANAGING A HOSPITAL’S CLINICAL CARE BUDGET: A TWELVE-STEP PROGRAM

David W. Young, D.B.A. Professor of Management Healthcare Management Program Pub

lic and Nonprofit Management Program Boston University School of Management and
Principal The Crimson Group, Inc., Cambridge, Massachusetts 22 July 2004
THE CRIMSON GROUP, INC.
THE FIRST ELEVEN STEPS
One-Time Step 1. Define the Organizational Structure Step 2. Determine Cost Driv
ers and Controlling Forces One-Time for Each Department Step 3. Forecast Revenue
from Clinical Care Annual Departments Step 4. Define Clinical Pathways and Step
-Function & One-Time Fixed Costs for Clinical Care Departments plus Annual Step
5. Determine Variable Cost per Resource Unit Updates Step 6. Estimate Service De
partment Step & Fixed Costs Step 7. Calculate Variable Cost per Case Type Formul
a Step 8. Compute the Surplus (Deficit) for Each Clinical Driven Care Department
Step 9. Compute Contribution to Hospital Overhead Annual Updates Step 10. Estim
ate Administrative Service Costs Formula Step 11. Compute Hospital’s Clinical Surp
lus (Deficit) Driven
THE CRIMSON GROUP, INC.
Step 1. Define the Organizational Structure
Hospital
Administrative Service Departments Patient Service Departments Clinical Service
Departments Clinical Care Departments Surgery Medicine Ob/Gyn Pediatrics Emergen
cy
Step 2. Determine Cost Drivers and Controlling Forces for Each Department
Administrative Service Departments Patient Service Departments Clinical Service
Departments Clinical Care Departments Examples Billing Legal Cost Driver Bill Ho
ur Controlling Force Admission Request Day of care Day of Care Admission MD Orde
r MD Order MD Order MD Order Admission Admission Visit
THE CRIMSON GROUP, INC.
Dietary Meal Laundry Pound Medical Records Record Radiology Pathology Pharmacy S
ocial Services Surgery Medicine Emergency Procedure Test Prescription Hour Case
(by DRG) Case (by DRG) Case type
Dietary Billing Radiology Laundry Fiscal Pathology Housekeeping Anesthesiology L
egal Development Plant Maintenance Pharmacy Medical Records Social Services
THE CRIMSON GROUP, INC.
Step 3. Forecast Revenue from Clinical Care Departments
Fiscal Affairs Fiscal Affairs Department Department
Forecasts
Step 4. Define Clinical Pathways and Step-Function & Fixed Costs for Clinical Ca
re Departments
Clinical Care Clinical Care #n Department Clinical Care #2 Department Department
#1
Forecasts
Clinical Care Clinical Care #n Department Clinical Care #2 Department Department
#1
Budget Budgeted Clinical Pathways
From Step 3
Payer Mix and Prices
Case Type n Case Type Number of cases B of DRG A
DRG n DRG B DRG A
Total Revenue Total Revenue Department Budgeted Revenue #2 #n Department Departm
ent #1
THE CRIMSON GROUP, INC.
Departmental Step Function and Fixed Costs
Average LOS Radiology procedures Lab tests Pharmacy Etc.
THE CRIMSON GROUP, INC.
Step 5. Determine Variable Cost per Resource Unit
Patient Service Departments Service Efficiency Protocols (e.g., minutes per medi
cal record) Wage rates and Supply unit costs Variable cost per Resource unit
Budgeted Amounts
Step 6. Estimate Service Department Step-Function and Fixed Costs
Each Patient Each Patient service service department department Service Need For
ecasts (e.g., number of meals, pounds of laundry, hours of housekeeping) Step-fu
nction and fixed costs needed to meet needs Each clinical Each clinical service
service department department Service Need Forecasts (e.g., number of x-rays, la
b tests, pharmacy requests) Step-function and fixed costs needed to meet needs
Clinical Service Departments Clinical Efficiency Protocols (e.g., minutes per x-
ray) Wage rates and Supply unit costs Variable cost per Resource unit
THE CRIMSON GROUP, INC.
Budgeted Amounts
Fixed cost budget Fixed department Step and fixed forcost budget #n cost budget
for department #2 for department #1
Fixed cost budget Fixed cost budget for department Step and fixed cost budget #n
for department #2 for department #1
THE CRIMSON GROUP, INC.
Step 7. Calculate Variable Cost per Case Type
Clinical Care Clinical Care Clinical Care Clinical Care #n Department Department
ClinicalCare #2 #n Department Clinical Care #2 Department Department #1 Departm
ent #1 Patient service departments Clinical service departments
Step 8. Compute the Surplus (Deficit) for Each Clinical Care Department
From Step 3 From Step 7
Total Revenue Total Revenue Budgeted Revenue Department Department #2 #n Departm
ent #1 Minus total budgeted Minus total budgeted Minus total budgeted costs for
variable variable costs for variable costsDepartment #n for Department #2 Depart
ment #1
From Step 5
Case Type n Case Type Number of cases B of DRG A
From Step 4
Variable cost per resource unit
Variable cost per resource unit
Budgeted variable cost Budgeted Budgeted cost n For variable DRG variable cost F
or DRG B For DRG A
From Step 4
Average LOS Radiology procedures Lab tests Pharmacy Etc.
Budgeted variable cost Budgeted Budgeted cost n For variable DRG variable cost B
For DRG for DRG A
THE CRIMSON GROUP, INC.
Minus total step function Minus step function and costs Minus totaltotal step fu
nctioncosts and fixedfixed and fixed for Department #n costs for Department #2 f
or Department #1 Equals Department #n’s Equals Department hospital’s contribution to
 #2’s Equals Departmenthospital’s #1’s contribution tosurplus (deficit) contribution t
o hospital’s surplus (deficit) surplus (deficit)
THE CRIMSON GROUP, INC.
Step 9. Compute Contribution to Hospital Overhead
From Step 8
Step 10. Estimate Administrative Overhead Costs
Each administrative Each administrative service service department department Ap
proximate level of activity (e.g., number of legal matters, personnel actions, f
inancial reports) Step-function and fixed costs needed to meet needs Fixed cost
budget Fixed cost budget for department Step and fixed department #2 #n for cost
budget for department #1
THE CRIMSON GROUP, INC.
Department #n’s Department contribution #2’s Department #1’s to hospital’s contribution
tosurplus (deficit) hospital’s contribution to hospital’s surplus surplus (deficit)
(deficit) Fixed cost budget Fixed cost budget Step and fixed cost budget #n forf
or department department for clinical service #2 department #1 Fixed cost budget
Fixed department Step and fixed cost budget #n for cost budget for patient for
department #2 service department #1
Total contribution from clinical care departments Minus step and fixed costs of
clinical service departments Minus step and fixed costs of patient service depar
tments Equals contribution to hospital’s administrative service departments
THE CRIMSON GROUP, INC.
Step 11. Compute Hospital’s Clinical Surplus (Deficit)
From Step 9
Patient Service Departments
Service Need Forecasts Service Efficiency Protocols Wage rates and supply unit c
osts Stepand fixed costs Variable cost per resource unit
Clinical Service Departments
Service Need Forecasts Clinical Efficiency Protocols Wage rates and supply unit
costs Stepand fixed costs Variable cost per resource unit Transfer Prices Depart
mental Step Function and Fixed Costs
Clinical Care Departments
Contribution to hospital’s administrative service departments
From Step 10
Average LOS Radiology procedures Lab tests Pharmacy Etc.
Number & type of cases
Payer Mix and Prices
Budgeted Revenue
Fixed cost budget Fixed cost budget for department Step and fixed department #2
#n for cost budget for department #1
Minus total administrative costs
Budgeted variable cost Per DRG
Minus total budgeted variable costs Minus Departmental step function and fixed c
osts Equals Department’s contribution to hospital’s surplus (deficit)
Administrative Service Departments
Approximate level of activity
Equals hospital’s surplus (deficit)
Equals contribution to hospital’s administrative service departments Minus total a
dministrative Service costs Equals hospital’s surplus (deficit)
Minus step and fixed costs
Minus step and fixed costs
Step-function and fixed costs
THE CRIMSON GROUP, INC.
THE CRIMSON GROUP, INC.
A SIMPLE EXAMPLE
STEP 3 Case Mix DRG A DRG B DRG C DRG D Total FORECAST REVENUE DEPARTMENT #1 PAY
ER #1 Forecast number of cases 60 200 100 50 Expected revenue per case $7,350 $1
,430 $2,020 $7,650 Total Revenue $441,000 $286,000 $202,000 $382,500 $1,311,500
PAYER #2 Forecast number of cases 100 50 300 150 Expected revenue per case $6,80
0 $1,500 $3,000 $7,400 Total Revenue $680,000 $75,000 $900,000 $1,110,000 $2,765
,000 TOTAL REVENUE $4,076,500 DEFINE CLINICAL PATHWAYS AND STEP-FUNCTION AND FIX
ED COSTS FOR DEPARTMENT DEFINE CLINICAL PATHWAYS DRG A DRG B DRG C DRG D Resourc
es from Clinical Service Departments No. of patient days per case 10 5 6 12 No.
of x-rays per case 5 1 2 3 No. of CBCs per case 10 5 3 12 Resources from Patient
Service Departments No. of meals per case 30 15 18 36 No. of pounds of laundry
per case 15 7.5 9 18 No. of medical records per case 1 1 1 1 STEP FUNCTION AND F
IXED COSTS AT FORECAST VOLUME AND MIX Step-function costs (e.g., nursing) $1,000
,000 Fixed costs (e.g. departmental administration) 1,500,000 TOTAL STEP AND FIX
ED COSTS AT ESTIMATED VOLUME AND MIX $2,500,000
THE CRIMSON GROUP, INC.
STEP 5 STEP 5A
STEP 4 STEP 4 A
STEP 5B
STEP 4 B
DETERMINE VARIABLE COST PER RESOURCE UNIT CLINICAL SERVICE DEPARTMENTS DRG A DRG
B DRG C DRG D CLINICAL EFFICIENCY PROTOCOLS No. nursing minutes per patient day
60 40 50 40 No. technician minutes per x-ray 40 40 40 40 No. technician minutes
per CBC 20 20 20 20 No. units of nursing supplies per patient day 10 3 5 8 No.
units of supplies per x-ray 3 3 3 3 No. units of supplies per CBC 4 4 4 4 WAGE R
AGES AND UNIT SUPPLY COSTS Cost per minute for nurses $0.50 $0.50 $0.50 $0.50 Co
st per minute for x-ray technicians $0.20 $0.20 $0.20 $0.20 Cost per minute for
lab technicians $0.20 $0.20 $0.20 $0.20 Cost per unit for nursing supplies $3.50
$3.50 $3.50 $3.50 Cost per unit for x-ray supplies $5.00 $5.00 $5.00 $5.00 Cost
per unit for CBC supplies $2.00 $2.00 $2.00 $2.00 VARIABLE COST PER RESOURCE UN
IT IN CLINICAL SERVICE DEPARTMENTS Patient day $65 $31 $43 $48 X-Ray $23 $23 $23
$23 CBC $12 $12 $12 $12 PATIENT SERVICE DEPARTMENTS DRG A DRG B DRG C DRG D SER
VICE EFFICIENCY PROTOCOLS No. minutes per meal 10 10 10 10 No. minutes per pound
of laundry 1 1 1 1 No. minutes per medical record 5 5 5 5 No. units of ingredie
nts per meal 5 5 5 5 No. units of laundry supplies per pound 3 3 3 3 No. units o
f supplies per medical record 2 2 2 2 WAGE RAGES AND UNIT SUPPLY COSTS Cost per
minute for meals $0.25 $0.25 $0.25 $0.25 Cost per minute for laundry $0.15 $0.15
$0.15 $0.15 Cost per minute for medical records $0.30 $0.30 $0.30 $0.30 Cost pe
r unit for dietary supplies $1.50 $1.50 $1.50 $1.50 Cost per unit for laundry su
pplies $0.30 $0.30 $0.30 $0.30 Cost per unit for medical record supplies $1.00 $
1.00 $1.00 $1.00 VARIABLE COST PER RESOURCE UNIT IN PATIENT SERVICE DEPARTMENTS
Meals $10 $10 $10 $10 Laundry $1 $1 $1 $1 Medical Records $4 $4 $4 $4
THE CRIMSON GROUP, INC.
STEP 6 STEP 6A
STEP 6B
STEP 7
STEP 8
ESTIMATE SERVICE DEPARTMENT STEP AND FIXED COSTS AT FORECASTED VOLUME STEP FIXED
TOTAL CLINICAL SERVICE DEPARTMENTS Nursing $350,000 $700,000 $1,050,000 Radiolo
gy 250,000 800,000 1,050,000 Laboratory 320,000 600,000 920,000 Total $3,020,000
STEP FIXED TOTAL PATIENT SERVICE DEPARTMENTS Dietary $180,000 $600,000 $780,000
Laundry 100,000 400,000 500,000 Medical Records 150,000 300,000 450,000 Total $
1,730,000 CALCULATE VARIABLE COST/CASE DRG A DRG B DRG C DRG D From Clinical Ser
vice Departments Nursing $650 $153 $255 $576 Radiology 115 23 46 69 Laboratory 1
20 60 36 144 From Patient Service Departments Dietary $300 $150 $180 $360 Laundr
y 16 8 9 19 Medical Records 4 4 4 4 TOTAL VARIABLE COST PER CASE $1,204 $397 $53
0 $1,171 COMPUTE THE SURPLUS (DEFICIT) FOR EACH CLINICAL CARE DEPARTMENT Revenue
 $1,121,000 $361,000 $1,102,000 $1,492,500 Minus Variable Costs 192,680 99,219 2
11,980 234,280 Equals Contribution to Step and Fixed $928,320 $261,781 $890,020
$1,258,220 $3,338,341 Minus Step and Fixed Costs 2,500,000 Equals Contribution t
o Clinical and Patient Service Step and Fixed Costs $838,341
STEP 9
STEP 10
STEP 11
COMPUTE CONTRIBUTION TO HOSPITAL OVERHEAD Contribution from Clinical Care Depart
ments (assumes 10 with same contribution) Minus Step and Fixed Costs of Clinical
Service Departments Minus Step and Fixed Costs of Patient Service Departments E
quals Contribution to Hospital Overhead STEP FIXED ESTIMATE ADMINISTRATIVE SERVI
CE COSTS Legal $250,000 $300,000 Human Resources 300,000 600,000 Fiscal Affairs
300,000 850,000 Total COMPUTE HOSPITAL S CLINICAL SURPLUS (DEFICIT) Contribution
to Hospital Overhead ` Minus Estimated Administrative Costs What if this is not
enough? Equals Hospital s Surplus (Deficit)
$8,383,413 3,020,000 1,730,000 $3,633,413 TOTAL $550,000 900,000 1,150,000 $2,60
0,000 $3,633,413 2,600,000 $1,033,413
THE CRIMSON GROUP, INC.
THE CRIMSON GROUP, INC.
Step 12. Fix It
Step 1. Define the Organizational Structure Step 2. Determine Cost Drivers and C
ontrolling Forces for Each Department Step 3. Forecast Revenue from Clinical Car
e Departments Step 4. Define Clinical Pathways and Step-Function & Fixed Costs f
or Clinical Care Departments Step 5. Determine Variable Cost per Resource Unit S
tep 6. Estimate Service Department Step & Fixed Costs Step 7. Calculate Variable
Cost per Case Type Step 8. Compute the Surplus (Deficit) for Each Clinical Care
Department Step 9. Compute Contribution to Hospital Overhead Step 10. Estimate
Administrative Service Costs Step 11. Compute Hospital’s Clinical Surplus (Deficit
)
THE CRIMSON GROUP, INC.
Step 12. Fix It
Step 3. Forecast Revenue from Clinical Care Departments Step 4. Define Clinical
Pathways and Step-Function & Fixed Costs for Clinical Care Departments Step 5. D
etermine Variable Cost per Resource Unit Step 6. Estimate Service Department Ste
p & Fixed Costs
Step 10. Estimate Administrative Service Costs
THE CRIMSON GROUP, INC.
OPTIONS AND CONSEQUENCES
Cost Driver
Case Mix
Option
Reduce the incidence or don’t treat certain diagnoses Don’t treat all patients with
certain diagnoses Treat certain case types with a more cost-effective mix of res
ources Provide resources in a less expensive way
Consequences
Morbidity may improve, or some patients will suffer and/or die prematurely. Some
patients will suffer and/or die prematurely. More outpatient care and shorter l
engths of stay in hospitals. Perhaps fewer tests and procedures. Lower wages, lo
wer supply prices, greater efficiency. Result is fewer staff and/or different sk
ill mixes. Less technology, fewer administrators, less qualified administrators.
THE CRIMSON GROUP, INC.
NUMBER OF CASES VERSUS COST PER CASE
Volume Resources Per Case Cost Per Resource Unit
NUMBER OF CASES
Fixed Facility Costs
Invest in lower cost capital, reduce size/salaries of administrative staff
LOW
MODE
HIGH
OUTLIERS
COST PER CASE
THE CRIMSON GROUP, INC.
NUMBER OF CASES VERSUS COST PER CASE
Example of New Inpatient Utilization Pattern
48 YEAR OLD PRESENTING WITH ATYPICAL CHEST PAIN, POSITIVE SMOKING AND FAMILY HIS
TORY, AND NORMAL EKG
CURRENT PATTERN
Admit to Telemetry ALOS = 2.2 days $2,800 $225 $175 $150 $350 $450
OPTIONAL PATTERN
Admit to Observation Unit $1,000 ALOS = 23 hours EKG x 2 Enzymes and Limited Blo
ods Cardiology Consult Echo Non-Thallium Stress Test $150 $75 $150 $350 $125
NUMBER OF CASES
BUT
Daily EKG x 3 Enzymes and Full Bloods Cardiology Consult Echo Thallium Stress Te
st
TOTAL COST
LOW MODE HIGH OUTLIERS
$4,150
TOTAL COST
$1,850
COST PER CASE
THE CRIMSON GROUP, INC.
AT AN INCIDENCE RATE OF 5/1000, THE PURCHASER WOULD SAVE $3.5 MILLION ANNUALLY
THE CRIMSON GROUP, INC.
THE PROBLEM: THEIR COST SAVINGS ARE YOUR REVENUE REDUCTIONS!
WHAT ARE THE IMPLICATIONS OF STEP 12 FOR DEPARTMENTS OF PATHOLOGY?
WHAT HAPPENS, FOR EXAMPLE, WHEN THE CLINICAL PATHWAY FOR ALL PATIENTS WITH DRG A
USES LIMITED RATHER THAN FULL BLOODS?
OR WHEN THE PATHWAY FOR ALL PATIENTS WITH DRG B CALLS FOR 2 RATHER THAN 5 CBCs?
THE CRIMSON GROUP, INC.
THE CRIMSON GROUP, INC.
BUT BUDGETING IS NOT ENOUGH. ANYONE CAN BALANCE A BUDGET THE HARD PART IS BALANC
ING THE ACTUALS! TO DO THAT YOU NEED A WELL-DESIGNED REPORTING SYSTEM
SPENSER REHABILITATION HOSPITAL REPORTING HIERARCHY (In Thousands of Dollars) Fo
r Month of June 2002 FIRST LEVEL REPORT: MACRO PROGRAM ANALYSIS For Board and Se
nior Management Over or Actual (under) budget This Year This Year Surplus (Defic
it) Month to date Month to date Inpatient-Weberg Inpatient - SRH Outpatient Rese
arch Education Ambulance Development Administration Total direct $2,110 $12,030
24,525 147,280 1,235 7,570 1,180 7,045 3,590 18,960 4,120 25,175 2,245 13,680 3,
630 22,965 $42,635 $254,705 $(315) $35 (710) (2,590) (125) (210) 95 75 (235) 245
160 (320) 180 (160) (70) (730) $(1,020) $(3,655)
VARIANCE ANALYSIS Contribution Margin Revenue Revenue Expense Price Payer Mix Vo
lume/Mix Volume/Mix Net
Expense Utilization Unit Cost
(50)
(320)
150
(90)
60
(250)
(150)
(710)
SECOND LEVEL REPORT: PRODUCT LINE ANALYSIS For Board and Senior Management Over
or VARIANCE ANALYSIS Inpatient - SRH Actual (under) budget Contribution Margin T
his Year This Year Revenue Revenue Expense Expense Month to date Month to date P
rice Payer Mix Volume/Mix Volume/Mix Net Utilization Unit Cost Product Line Brai
n Injury $5,340 $35,845 $(625) $(1,380) Spinal Cord Injury 3,310 19,605 (30) (62
0) (10) (50) 200 (100) 100 (50) (20) Stroke Rehabilitation 3,115 18,085 90 (135)
Post-polio Rehabilitation 5,740 33,635 (65) (640) Pediatric Rehabilitation 7,02
0 40,110 (80) 185 (30) Total direct $24,525 $147,280 $(710) $(2,590)
THE CRIMSON GROUP, INC.
THE CRIMSON GROUP, INC.
SPENSER REHABILITATION HOSPITAL REPORTING HIERARCHY (In Thousands of Dollars) Fo
r Month of June 2002 THIRD LEVEL REPORT: DRG ANALYSIS For Senior Management and
Program Managers Spinal Cord Injury Actual This Year Month to date $895 $5,400 1
,030 7,000 760 4,500 625 2,705 $3,310 $19,605 Over or (under) budget This Year M
onth to date $119 $75 176 (50) (160) (350) (165) (295) $(30) $(620) VARIANCE ANA
LYSIS Contribution Margin Revenue Revenue Expense Price Payer Mix Volume/Mix Vol
ume/Mix Net 0 0 200 (150) 50
SPENSER REHABILITATION HOSPITAL REPORTING HIERARCHY (In Thousands of Dollars) Fo
r Month of June 2002 FIFTH LEVEL REPORT: PHYSICIAN ANALYSIS BY DRG For Director
of Medical Staff Over or VARIANCE ANALYSIS Actual (under) budget Contribution Ma
rgin This Year This Year Revenue Revenue Expense Expense Physician 1 Month to da
te Month to date Price Payer Mix Volume/Mix Volume/Mix Net Utilization Unit Cost
DRG 1 $245 $1,300 $(35) $(65) 0 0 150 (100) 50 (40) (45) (35) DRG 2 90 560 (25)
(50) DRG 3 75 350 (20) (80) DRG 4 45 280 15 95 DRG 5 35 110 (5) (30) Total $490
$2,600 $(70) $(130) Physician 2 Etc.
Expense Utilization Unit Cost 160 (91)
DRG 1 DRG 2 DRG 3 DRG 4 Total
FOURTH LEVEL REPORT: DRG ANALYSIS BY PHYSICIAN For Program Managers and Physicia
n Chiefs Spinal Cord Injury Actual This Year Month to date $245 $1,300 300 1,775
150 780 200 1,545 $895 $5,400 VARIANCE ANALYSIS Over or Contribution Margin (un
der) budget Revenue Revenue Expense Expense This Year Price Payer Mix Volume/Mix
Volume/Mix Net Utilization Unit Cost Month to date $(35) $(65) 0 0 150 (100) 50
(40) (45) 20 120 35 165 99 (145) $119 $75 0 0 200 (150) 50 160 (91)
THE CRIMSON GROUP, INC.
DRG 1 Physician 1 Physician 2 Physician 3 Physician 4 Total
SIXTH LEVEL REPORT: DRG ANALYSIS BY PHYSICIAN AND COST CENTER For Physician Chie
fs and Physicians UTILIZATION VARIANCE ANALYSIS BY DEPARTMENT Spinal Cord Injury
Over or DRG 1 Actual (under) budget Routine This Year This Year Lab Rad Pharm.
PT Care Other Total Month to date Month to date Physician 1 $245 $1,300 $(35) $(
65) 10 (50) 20 50 (50) (20) (40) Physician 2 300 1,775 20 120 (40) Physician 3 1
50 780 35 165 Physician 4 200 1,545 99 (145) Total $895 $5,400 $119 $75
THE CRIMSON GROUP, INC.
WHAT MIGHT A REPORTING SYSTEM WITH SOME OF THESE CHARACTERISTICS LOOK LIKE IN A
DEPARTMENT OF PATHOLOGY?
• • REPORTING HIERARCHY WITH DRILL DOWN CAPABILITY VARIANCES BETWEEN BUDGET AND ACTU
AL RESULTS COMPUTED BY COST DRIVER IDENTIFICATION OF INDIVIDUALS WHO HAVE RESPON
SIBILITY PERFORMANCE COMPARED TO PEERS
PLEASE KEEP IN TOUCH David W. Young DWY204@cs.com www.davidyoung.org www.thecrim
songroup.net
• •
THAT’S THE ISSUE IN LOMITA HOSPITAL
THE CRIMSON GROUP, INC. THE CRIMSON GROUP, INC.