HLTH5653 Module 4 operating budget paper example

Every Assumption on the Page: A Next-Year Operating Budget Built From Discharges, a 1.36 Case Mix Index and a Payer Mix That Keeps Moving

Student Name

American College of Education

HLTH5653: Financial Analysis and Assessment in Healthcare Administration

Module 4 Assignment

Instructor Name

July 24, 2028

Why Write the Assumptions Down

A budget is a set of predictions, and the predictions that matter most are the ones about how many patients will come, how sick they will be and who will pay. When those assumptions are buried inside revenue figures, nobody can tell during the year whether a variance comes from a wrong assumption or from poor management. The invented county hospital followed through this course lost $2.2 million on operations last year, and the previous modules traced the loss to labor costs and a shift in payer mix. This budget states each assumption separately, builds revenue and expenses from them and tests the ones most likely to be wrong. All dollar figures are in millions.

The budget year's statistical assumptions are these. Inpatient discharges rise 1 percent, from 6,420 to 6,480, as the county's aging population offsets the loss of some elective surgery to a competing outpatient surgery center. The case mix index, the average relative weight of the diagnosis-related groups treated, falls from 1.38 to 1.36, because the elective joint replacements moving to the surgery center carry higher weights than the medical admissions replacing them. Outpatient visits rise 3 percent, and emergency visits stay flat at about 24,500. A volume assumption without a case mix assumption beside it will overstate the revenue of every hospital losing surgical cases.

Building Revenue

Net patient revenue starts from last year's $212.4 and changes through five assumptions. Inpatient services produce about 58 percent of net patient revenue, $123.2. A 1 percent increase in discharges combined with a case mix index 1.4 percent lower reduces inpatient revenue by about $0.6, because per-case payers pay for the weight of the case, not only its occurrence. Outpatient services, $89.2, grow with volume by 3 percent, adding $2.7. Medicare's published annual update of 2.8 percent adds about $2.3 on Medicare's $83.1. The state has frozen Medicaid rates, adding nothing. The largest commercial contract, renewed four months before the end of the budget year, is budgeted at a 4 percent increase for those four months, adding $1.2.

Payer mix is budgeted to continue shifting by one point from commercial to Medicare, as Module 3 projected, reducing net revenue by $1.6. Net patient revenue therefore totals $216.5, an increase of 1.9 percent. Other operating revenue, mainly cafeteria, pharmacy sales to outside clinics and rental income, rises slightly to $8.8, for total operating revenue of $225.3. The commercial rate assumption is deliberately cautious. Frakt (2011) found that hospitals shift costs to private payers at a relatively low rate and that relative market power shapes private prices, so the budget does not assume the insurer will cover the hospital's public shortfall.

Building Expenses

Salaries and benefits start at $121.5. A 3.5 percent wage and benefit increase adds $4.3, and staffing for higher outpatient volume adds $0.8. The largest labor decision in the budget is to convert 18 traveling nurse and therapist positions to hospital employees, adding $2.1 in salaries and benefits at about $118,000 per loaded position and $0.4 in retention bonuses. Salaries and benefits therefore total $129.1. The conversion reduces contract labor, part of purchased services, from $7.4 to $4.0, so purchased services fall from $29.4 to $26.4 after 2 percent inflation on the remaining services. The conversion saves about $0.9 overall in its first year and more in later years, when the bonuses end.

Supplies rise 3 percent for price and 1.5 percent for volume, to $40.5. Depreciation rises to $13.6 with the equipment placed in service this year, interest falls to $3.9 as debt is repaid, and other expenses rise to $16.8. Total operating expenses are $230.3, and the base case operating result is a loss of $5.0, larger than last year's. A budget that shows a bigger loss than last year is not a failure of budgeting; it is a budget that told the truth in time.

Management Actions and Their Evidence

Management proposes four actions to narrow the loss, each estimated separately. First, standardizing orthopedic and cardiac implants and surgical supply preference cards is estimated to save $1.2, based on the supply chain department's comparison of current prices with the group purchasing organization's contract tiers. Second, a revenue cycle project to reduce initial claim denials from 11 percent to 8 percent is estimated to add $1.4 in net revenue from claims now written off, and would also reduce days in receivables. Third, an internal float pool of 12 nurses, hired in the second half of the year, would replace a further $1.0 of contract labor. Jones (2008) describes a method for estimating nurse turnover costs and adjusting them for inflation, which allows nurse executives to calculate the savings from retention investments; the hospital's own turnover cost estimate, built with that method, supports the retention bonuses in the conversion above.

Fourth, a project to reduce average length of stay from 4.6 to 4.4 days is included, but at a deliberately small saving of $0.3. Taheri et al. (2000), analyzing the costs of 12,365 hospital stays, found that the last full day of a stay accounted for only 2.4 percent of the average total cost, and that reducing a stay by a full day reduced total cost by 3 percent or less, because most variable costs occur early in an admission. Shorter stays are valuable mainly for freeing capacity, so the budget does not count on them to cut costs. Together, the actions total $3.9, reducing the operating loss to $1.1.

Nonoperating Income and the Covenant

Last year, $7.9 of investment income covered the operating loss. The budget assumes $4.0, a return of 3.5 percent on $114.6 of cash and investments, which is the portfolio's long-run average rather than last year's strong return. With the actions, the excess of revenue over expenses is budgeted at $2.9. Debt service coverage would be about 2.2, adding the excess, depreciation of $13.6 and interest of $3.9 and dividing by principal and interest due of $9.3. Without any investment income, coverage would be about 1.8, above the covenant minimum of 1.25.

Which Assumptions Matter Most

The sensitivity of the result to each assumption tells managers where to watch. Each 0.01 change in the case mix index moves inpatient revenue by about $0.9, so if the index falls to 1.34 rather than 1.36, the operating loss widens by about $1.8. Each 1 percent change in discharges moves revenue by about $1.2 and variable costs by about $0.5, a net effect of $0.7. If the commercial contract is renewed at 7 percent rather than 4, revenue rises by about $0.9 in the budget year. If the travel nurse conversion is delayed six months, the loss widens by only about $0.5 in the budget year, because the hospital would not yet be paying the new employees either, but the delay would push back the larger savings expected once the bonuses end. The payer mix assumption matters every year: each additional point of shift costs another $1.6.

These sensitivities show that case mix and payer mix, not discharges, are the assumptions that most need monthly attention, which is the opposite of how the hospital's monthly report has traditionally been organized, around volume.

Monitoring the Budget

The budget will be reported monthly as a flexible budget, which adjusts expected revenue and variable expenses to actual volume and case mix, so that variances separate what volume and case mix caused from what management controlled. The monthly report will show each of the stated assumptions beside its actual value: discharges, case mix index, outpatient visits, payer mix, commercial rate, contract labor spending and the progress of each management action. If case mix falls below 1.35 for two consecutive months, or the conversion falls more than two months behind, the finance committee will review the forecast. A budget built from written assumptions can be corrected when an assumption proves wrong; a budget built from last year's totals can only be missed.

References

Frakt, A. B. (2011). How much do hospitals cost shift? A review of the evidence. The Milbank Quarterly, 89(1), 90-130. https://doi.org/10.1111/j.1468-0009.2011.00621.x

Jones, C. B. (2008). Revisiting nurse turnover costs: Adjusting for inflation. Journal of Nursing Administration, 38(1), 11-18. https://doi.org/10.1097/01.NNA.0000295636.03216.6f

Taheri, P. A., Butz, D. A., & Greenfield, L. J. (2000). Length of stay has minimal impact on the cost of hospital admission. Journal of the American College of Surgeons, 191(2), 123-130. https://doi.org/10.1016/S1072-7515(00)00352-5