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Northeast Laboratory Conference
Key Financial Indices for a Laboratory Success Story
Portland, ME
October 17, 2018
Rodney W. Forsman
CLMA LCRC, FAAC Member
Assistant Professor Emeritus, Laboratory Medicine and Pathology, College of Medicine, Mayo Clinic
Financial Disclosures
Consultant Fees: Glenview, Gerson Lehman, AlphaSights, expert witness testimony
Board Membership/Stocks: Path-Tec
Expenses: NE Laboratory Conference
Federal Entitlement Programs: Medicare, Social Security
Learning Objectives
Recognize the basics of how to measure profitability
Express revenue recognition and the keys to a successful reimbursement program
Calculate the financial effects of volume on cost
Differentiate between fixed and variable costs
Formulate DRO and other key financial variables
10 Most Concerning Issues for Hospital CEOs
1. Financial challenges
2. Government mandates
3. Patient safety and quality
4. Personnel shortages
5. Patient satisfaction
6. Access to care
7. Physician-hospital relations
8. Population health management
9. Technology
10. Reorganization (e.g., M&A, restructuring, partnerships)
ACHE, Top issues facing hospitals 2017https://www.ache.org/pubs/research/ceoissues.cfm
Within financial challenges
1. Medicaid reimbursement
2. Increasing costs for staff, supplies, etc.
3. Reducing operating costs
Vertical Competitors
Taking Margin
Insurers Horizontal Competitors
Taking Patients
Other Medical Centers
Substitute Competitors
Activities/Margin
Imaging Centers
Surgi-Centers
Commercial Labs
Mobile MRIs
Cataract Institutes
Medical Centers Compete in Three Dimensions
Measuring Profitability
Income Statement or Profit and Loss statement (P&L)
Statement which measures results of an enterprise for a period of time
The income statement typically includes the enterprise’s revenues, expense and income or loss for the year
If net income you’re in the black
If loss, you’re in the red
Measuring Profitability
Revenue
- Expense
= Profit (contribution margin)
So why is it so difficult to get the numbers?
Hurdles to Understanding Profitability Outreach transactions get lost in the
hospital reporting systems
No specific identification of outreach program revenue
No specific identification of outreach costs
All costs are not captured
Cost are buried in other departments
Phlebotomy costs in a nursing cost center
Courier costs in materials management
Hurdles to Understanding Profitability Cost shifting and indirect expense
allocations
Lack of specific information regarding reimbursement
Revenues are commingled with in-patient charges
Specific bad debt rates are unknown
Identifying revenue and cost is key
Establish separate cost centers to capture direct costs (couriers, phlebotomy, supplies, etc.)
Agree on a pre-test analytical cost
Use a separate identifier (prefix, suffix, division code etc.) to capture outreach related revenues
Reimbursement and Revenue Recognition Defining Net Revenue:
Gross Charges (charge
schedule) $1,000,000
Less Contractual Allowances (A) 400,000
Less Discounts (B) 92,000
Equals Net Net Revenue $508,000
(A) Difference between gross charges and amounts legally
entitled to receive from an insurance plan (third party payer)
(B) Further amounts off for specific payer or clients (i.e.,
employer contract for services, or % off charge agreement)
Lack of Focus
Billing and Collections get lost in the hospital Billing and Collection systems
Claims of $20 - $50 may get little attention, large claims take precidence
Remote registration leads to inadequate data necessary to submit clean claims
Several Questions
How do I calculate my cost per test?
How can I accurately measure productivity?
How do I know what to charge?
Types Of Cost
Direct Test related Reagents Supplies Personnel time
Indirect Not directly attributable to a given test
Utilities Insurance Maintenance
Types Of Cost
Fixed Constant costs Overhead Depreciation
Variable Volume Dependant
Reagent Supplies
Types Of Cost
Direct
Indirect
Fixed Variable
Reagents
Labor
Equipment
Labor
Building
Institutional
Overhead
Electricity
Variable Cost Approximation
Variable Cost = ———————
Delta Volume
Delta Cost
Variable Cost Approximation
Previous volume = 1,000,000
Current volume = 2,000,000
Previous cost = $10,000,000
Current cost = $15,000,000
Variable Cost Approximation
Variable Cost = ———————
1,000,000 tests
$5,000,000
= $5.00 per test
Volume Effect on Unit Cost
Year 1 2
Variable Costs
($5.00/test)
$500,000 $600,000
Fixed Costs $200,000 $200,000
Volume
100,000 120,000
Unit Cost $7.00 $6.66
Increased volume can lower unit test cost by spreading fixed costs…assume 20,000 incremental volume
0
20
40
60
80
100
120
140
200 400 800 1200 1800 2200 3200
Volume
Co
st
per
test
Cost per test
Current Fee
Fixed costs
Average Cost Per Test Curve
Cost Allocation
The accuracy of the cost analysis program depends largely on the methods used for allocating expenses
Beware of
Outdated standards
Averages or “tweaking”
Manufacturer’s estimates
Overhead allocations based on volume
Costing Methods
Cost Allocation
Price based costing
Activity based costing
Management Tools Workload recording
Personnel utilization
Cost accounting
Cost effectiveness
Why Cost Accounting
Determine Break-even Point
Determine cost at capacity
Establish pricing
Measure contribution margin
Analyze laboratory expenses by procedure
Benchmarks
Personnel cost (% of Rev) 40-42%
Supply cost 15-19%
Rev/Employee/yr $60-70K
Rev/billable test $17-28
Tests/Mo/FTE (all staff) 450
Tests/Mo/FTE (technical) 765
Profit (% of Rev) 8-12%
Pro Forma Estimates
Revenue and cost:
$17 revenue/test
$12 total direct cost/test
$4.15 variable cost/test
$2.00 cost/test (logistics, sales, billing..)
Typical hospital with no outreach:
50% fixed cost
50% variable cost
What to Know to Price Lab Services
Variable and fixed costs of performing the test plus margin
Administrative outreach costs
Calculate your cost per test at capacity as well as based on current actual
Discounting - June 18, 2007
OIG withdraws proposed rule
Lacked information to establish a single numerical benchmark
Insufficient to ascertain if it would have the unintended effect of raising health care costs
Updating fee schedules is principal protection against overpaying
Discounting
Medicare Fee Schedule is not cost
Common practice within the industry
Not specifically prohibited by government regulations
Viewed by the government as discounted fees, not multiple fee schedules
Discounting
Recommendations
Establish pricing based on actual costs
May chill “loss leader” pricing by others
Share with those who ask for deep discounts
What is DSO/DRO?
Acronym for “Days Sales Outstanding” or “Days Revenue Outstanding”
Measures amount of time from month of sale to collection of cash
Calculation methods vary
Simple Method Example
Net A/R at June 30 $700,000
June Net Revenue $1,800,000
June YTD Revenue per
day ($1.8M / 181 days)
$10,000
DRO (AR/YTD Rev)
70 days
Exhaustion Method Example Days
Net A/R at June 30 $700,000
Exhaust:
June Net Revenue $300,000 30
Remainder $400,000
May Net Revenue $300,000 31
Remainder $100,000
April Net Revenue $300,000 10 *
71 DRO
*Since April remainder is less than the month’s net revenue
then divide the remainder ($100K) into the revenue and multiply
by the number of days in that month. ($100,000 ÷ $300,000) x 30
What Influences Your Bad Debt
Timely follow-up on claims not processed in 45-60 days
Timely follow-up on patient balance (once a month)
Strict monitoring on accounts 90 days or greater outstanding
Complete and accurate verification of insurance eligibility at time of testing
Balance Sheet
Balance Sheet aka Statement of Position
Statement which shows the financial condition of an enterprise at a point in time
The balance sheet typically includes values of an enterprise’s assets, liabilities, and equity or net worth
Balance Sheet
Assets equal Liabilities and Equity
Cash Flow
Cash Flow or Statement of Funds Flow
Statement which shows the change in cash over a period of time
NOI plus/minus changes in non-cash items (depreciation, change in AR, etc.) equals change in cash
Role Financial Ratios Play
Monitoring Key Financial Ratios can serve several important purposes :
Key Financial Ratios represent good (yet simple) measures of the current financial strength
Trends emerge highlighting important developments that may warrant corrective actions
Role Financial Ratios Play
Financial performance and credit ratio levels are also among a number of important factors assessed by external parties such as Moody’s and Standard & Poor’s in their bond rating of an organization
Measuring Performance
Performance of the lab
Performance of the management
The Role of Management
To optimize the return on resources entrusted to it
Money
Building, materials, equipment
People
Time
Measuring Success
Decease in controllable cost per unit of service
Volume filling excess capacity
Contribution to margin
Contribution in Net Operating Income
Measuring Success
Enrichment of the practice
Broader test menu creates efficiency in clinical practice
Market demands enhance service
46
Key to Success
Build Service
Sell Service
Deliver Service
Enhance Service
Financial Opportunities
Episode of care cost reduction through improved service by enhanced or retained test repertoire and turnaround time
Market opportunities exist for significant additional test volume from the community
Additional test volume spreads fixed cost, lowers unit cost
Revenue less cost for outreach testing provides additional contribution margin
Length of Stay
The number of fixed reimbursement patients is increasing (Medicare DRG and OPPS, PMPM plans, etc.)
Avoid an entire inpatient encounter
Reduce length of stay
Length of Stay
Average cost per inpatient day*
Non-profit ($1,332-$3,273)
For-profit ($787-$3,173)
*Relators Insurance Marketplace 2014
Recommendations
Budget for decreased reimbursements
Community labs need to continue to demonstrate the value of service and integration over price
Questions