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St. Jude Children’s Research Hospital International Outreach Program. Seventh Meeting Calvo MacKenna BMT Cost Study December 19, 2007. Agenda. Discuss Chapter 12 and 15 End of Meeting Administration. Chapter 12 Outline. Chapter 12: Measuring Productivity Productivity
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St. Jude Children’s Research HospitalInternational Outreach Program Seventh Meeting Calvo MacKenna BMT Cost Study December 19, 2007
Agenda • Discuss Chapter 12 and 15 • End of Meeting Administration
Chapter 12 Outline Chapter 12: Measuring Productivity • Productivity • A measurement of inputs required to produce an output • An area where the use of cost accounting ratios provide information for improving management of a health care organization • Cost accounting has begun to focus on the problems related to productivity measurement
Productivity Measurement • The measurement of productivity • Hard to determine in industries, including health care • The difficulties arise from the problems related to quality and outcomes measurement • Outputs are difficult to define in health care • The actions of employees determines how productive the health care organization will be
Productivity Defined • The ratio of any given measure of output to any given measure of input over a specified time period • Most common productivity measure is output per labor hour • Measures only part of the organization’s productivity • Does not account for the amount of capital equipment used in producing the output • Either state the results in dollar terms or in physical units
Total Productivity • The ratio of total outputs to total inputs • The amount of output per unit of input • Usually expressed in dollar terms • Shows the financial benefits of improved productivity • Considers the increase in wages or the price of supplies, as well as the quantity of inputs consumed • Must exercise caution to keep the unit of evaluation constant over time
Total Productivity Total Outputs Total Inputs Total Productivity = • From a finance standpoint we measure productivity as follows, Operating revenue Supplies + labor + capital + overhead P =
Total Productivity Problems • When using dollar amounts, inflation can cause problems • Have to keep the calculations in constant dollars • Potential changes in quality • Productivity measures assume that quality is held constant • The total productivity ratio is inadequate to segregate the impact of case-mix changes from the impact of productivity changes
Partial Productivity • A measure of output compared with a partial measure of input • More frequently measured in physical units • Useful for labor negotiations, monitoring continued efficiency of operations, and identifying places to improve the operations of health care organizations Total Outputs Partial Inputs Partial Productivity =
Partial Productivity Example • We will consider the technician labor hours necessary for a computed tomography (CT) scan • We are assuming that CT scans come in only two types, head and body *N/C = Data not collected
Statistics from Partial Productivity Actual output hours Baseline output hours • Index of output = × 100% = 102.3% • Our output increased by 2.3% over the base period • Index of labor hours = ×100% = 97.7% • We actually worked only 97.7% as many hours in the current period as in the baseline case. • Index of output per labor hour = × 100% = 104.7% • Our output in the current period per labor hour is 104.7% of that in the baseline period. Actual labor hours Baseline labor hours Index of output Index of labor hours
Productivity and Indirect Costs • An alternative to the traditional comparison is to develop a productivity measure based on the comparison of direct costs and indirect costs • Many departments in a health care organization use some resources in direct patient contact and other resources indirectly • If there is a relationship between hours of direct patient care time and indirect time then we can monitor this on a monthly basis to see if productivity is being improved or maintained
Managing Discretionary Costs • A major challenge for management • Costs incurred in departments that are essential to the organization but that do not have simple input-output relationships. • Examples: personnel, marketing, legal, finance, administration, housekeeping and security • Productivity is difficult to assess in these circumstances. • Health care costs can be classified into three broad categories • Engineered costs • Committed costs • Discretionary costs
Engineered Costs • Costs for which there is a specific input-output relationship • These relationships can be readily observed • Normally include the direct materials and direct labor cost • Can be controlled by using flexible budget variance reports • Examples • More patient days require more meals from the dietary department • More X-rays require more sheets of X-ray film
Committed Costs • Costs that cannot be changed in the short run, such as during the coming year • They are generally reviewed as part of the capital budget process • Once committed to they usually do not vary from year to year • Changes in volume of services provided often have no effect on the committed costs • Examples • The depreciation cost on a nursing home building. • Long-term leases • Depreciation on equipment • Insurance
Discretionary Costs • Are costs that are incurred, typically each year, in an amount that is approved as part of the normal budget process • Sometimes referred to as managed costs • The budget for discretionary costs is generally based on negotiation.
Zero-Base Review • Zero-base Budgeting • Requires that all costs be examined and justified • Requires examination of alternatives • Expensive and time-consuming • Usually done once every five years • Most effective in terms of discretionary costs because they do not have a clear relationship between inputs and outputs • Helps you understand what types of objectives are being accomplished by discretionary cost centers and what resources are being devoted to accomplishing the various objectives
Work Measurement • Another approach to dealing with discretionary costs is to perform a review of activities with the hope of converting a discretionary cost center into a engineered cost center • Work measurement is a technique that evaluates what a group of workers needed to accomplish the task efficiently • Example: the mail room • It would be hard to relate mail room costs with patient days. • But you could relate pieces of mail sent out and pieces of mail received and sorted • With the proper measurement of the type of work being performed, it might be possible to reclassify many costs as engineered.
Efficiency and Effectiveness • Effectiveness • A measure of the degree to which the organization accomplishes its desired goal • Measuring effectiveness • A set of goals should be established for the discretionary cost center • Must evaluate to see if the goals have been met • If the goals are met then the department is effective • Efficiency • A measure of how close an organization comes to minimizing the amount of resources used to accomplish a result • For a given result, the organization should attempt to minimize the cost of the resources required
Effectiveness & Efficiency • By examining effectiveness and efficiency one can determine 1. Whether or not the goals were achieved 2. The cost of what was actually achieved • We must look at both effectiveness and efficiency • There can be trade offs between the two • Sometimes to be effective we have to be less efficient • Healthcare tends to sacrifice some efficiency for effectiveness
Effectiveness & Efficiency • Goal is to have effectiveness and efficiency in balance
Effectiveness & Efficiency • Approaches to ensure the efficiency and effectiveness of a discretionary cost department • Thorough review of all budget elements • Development of monitoring tools for assessing efficiency and effectiveness • Introduction of competitive market forces • Leadership • Formalized spending approval mechanism • Promotion of an organizational culture
Chapter 14 Outline Chapter 14: Dealing with Uncertainty • Health care managers make many decisions after first making financial estimates. • Potential revenues and costs are predicted based on a number of calculations, and decisions are based off of these. • A degree of uncertainty is inherent in such estimates. • We will look at four common approaches that help improve the predictions made and used for decisions.
The Expected Value Technique • Expected value analysis • Estimates the costs or revenues based on the likelihood of each possible outcome • Key focus is on the possible events that might occur • Management can take actions to affect the outcomes, but events are occurrences that are beyond the control of managers • A weighted average of the outcomes with the probabilities of each outcome serving as the weights • Outcomes are measured in monetary terms
Using Expected Value • To calculate, first establish a probability distribution for the possible states of nature • Example: • Suppose that there is a 25% chance that the competitor will be a lithotriptor and a 75% chance that it will not, if we buy one. • Suppose that the profits from 1,000 patients are expected to be $50,000, whereas the loss related to 700 patients will be $150,000 Lithotriptor Project
Using Expected Value • To determine the expected value of this project: • The large potential loss is so great that it just offsets the benefit from the probable gain, and the expected financial result is zero. • The hospital may still buy the machine to keep physicians happy and to improve the hospital’s reputation and service to the community
Full Range of Possible Events • In making decisions based on expected value, we must consider all possible states of nature that might occur. • We have only considered 2 options: • We buy and they do not • We buy and they buy • But there are two more options that need to be considered: • We do not buy and they do not buy • We do not buy and they buy
Subjective Estimates • Subjective probability • A probability that is based on a manager’s estimate rather than known odds • All our estimates are based on it • Managers must use their knowledge, experience, and judgment to make a best guess about the likelihood of each event. • There is always a risk that unknown negative factors not taken into account will determine the probabilities. • Therefore, many organizations demand a substantial positive expected value to move forward with a project.
Subjective Estimates Example (pg. 311) • The probability changes Competitor Competitor
Another Expected Value Example • Suppose that we are planning the staff level for the emergency department (ED). • The ED managers know that it is most economical to staff the ED at just the level needed to provide care to all patients who arrive. • The cost per patient is minimized when the staffing pattern is correct for the volume of patients. Cost/Patient ($) Low Medium High ER Cases Probability Staff Staff Staff 20,000-25,000 .10 50 60 70 25,001-30,000 .40 55 50 60 30,001-35,000 .35 60 50 55 35,001-40,000 .15 70 60 50
Simulation Analysis • A tool that can take the various errors in all the estimates into account and provide managers with the likelihood of actual results being substantially different from the budgeted projection. • Avoids ignoring the possibility of unfavorable outcomes compounding other unfavorable outcomes • Helps improve the accuracy of the decisions managers make • Frequently used in health care
Sensitivity Analysis • Allows managers to consider various possible actual results and see their impact on the projection. • Tells a manager how sensitive the profits of the venture are to any given change in one or more variables. • Done using a spreadsheet program, such as Excel • Requires management judgment in determining a reasonable set of “what-if” assumptions.
Probabilistic Example • Based on a manager’s subjective estimate of what is most likely to occur. • The most likely outcome is generally the one the manager has used to make the original estimates for the projection. • When making a projection, the probabilistic nature of the estimate is often ignored. • Does not give the manager a sense of how likely or unlikely the result is to occur.
Simulation Technique • Similar to a sensitivity analysis, except it goes further in generating a value for each variable in the model. • The key to simulation analysis is that the value chosen for each variable is based on a probability distribution. • Managers must indicate how likely they believe a variable is to take on a variety of different values. • Will select each of the values on a random basis, adjusted for probability.
Implementing Simulation Results • The manager must use the simulation results in making a decision. • Relatively profitable and unprofitable organizations can afford to take risks, but those that fall in the middle are in a difficult position. • Most small to medium size health care organizations fall in the middle.
Limitations of Simulation Analysis • Primary concerns • May be prohibitively costly • The model may be built incorrectly • The probability estimates may be incorrect
Network Cost Budgeting • A popular management tool used for planning and controlling nonroutine, complex projects • May be beneficial for some ongoing activities • Uses arrow diagrams, that finds a critical path that determines the least amount of time for project completion • Refers to combining the techniques of network analysis with cost accounting to generate the most cost-effective approach to the project. • Often assumed that the network is laid out in an optimal fashion, but it can indicate other possible timelines. • Use overtime or extra staff reduces the amount of time, but the cost usually increases
Network Analysis • Uses a diagram to show the relationships in a complex project • Arrows represent specific activities that must be done • Crucial aspect: identifying the activities that must be completed before some other activity or activities can commence
Network Analysis Example • Assume that a hospital has determined midway through the year that revenues are below expectations and a financial crisis is anticipated. • The Decision: Select five departments that have the potential for budget cuts that would help offset the crisis • A zero-based review is conducted in each one. • Each element of the budget is reviewed and its role determined • Based on the information from the review, a decision would be made concerning how much to cut from the operating budget of each department.
Network AnalysisExample (pg. 320) • Each activity starts at a numbered point • Each activity has a number at its start and at its completion • The activity can be identified by these two numbers • Examples: Activity 1-2 or Activity 2-4
Network Analysis Example (pg. 321) • An alternative presentation is to place each activity into a “node” • You identify each activity by referring to it by the name or description in the node
Critical Path • Always found as an element of network analysis • To find: it is necessary to determine the expected length of time for each activity • Critical path method (CPM) • A program of techniques that indicates the cost and time for each element of a complex project and indicates cost/time trade-offs where applicable
Critical Path Example • Assumed that an initial plan was developed as follows: • Develop an audit plan, assign staff, schedule audits: 31 days • Audit Department A: 22 days • Audit Department B: 15 days • Audit Department C: 13 days • Audit Department D: 9 days • Audit Department E: 19 days • Review audit results: 31 days • Make budget modification decisions (top management), hear appeals, make final decision: 31 days • All days are shown, including weekend days. • In this plan, it was not assumed that any work would take place on weekends.
Critical Path • Decided there would be two teams of auditors • Fastest approach • One team: Audits A and then E • Other team: Audits B, C, and D
Critical Path Example (pg. 322) • One route or path through the network is 1-2-3-5-6-7-8 • The total days: 130 • The other route or path through the network is 1-2-4-6-7-8 • The total days: 134
Critical Path • Determined by totaling the days required for each possible route through the network and finding the longest one. • All tasks must be undertaken. • The project can be achieved in no less time than the time it takes for the longest path.
Benefits of Planning • Planning takes time • Conducting a zero-base budget review requires a careful audit plan. • Meetings must be held to determine the goals of the audit and the specific audit activities. • Auditors and departments have to schedule a mutually convenient time to do the audit. • Tasks make up Activity 1-2 • A review of the plan by the top management can result in determining how important each activity is • If the activity is important enough, then the individuals involved will be told to set all else aside temporarily. • Audits should begin as soon as the auditors are ready.
Revised Network Example (pg. 323) • Revised network has a new critical path that is only 65 days long. • More than half if the project time has been eliminated by indicating priority. • Reflects the significant benefits that can be obtained by creating and reviewing a plan before starting work on a project.
