Financial Decision Modelsin an Era of Reform

Tom EaleyAlma CollegeAlma Michigan

Financial Decision Models in an Era of Reform

Tom is the author of:

RX for Business Success: Starting a Medical Practicean MGMA publication

© MGMA, 2007

Financial Decision Models in an Era of Reform

The contents of the seminar are not intended to be legal or professional advice. Such advice should be obtained from experienced, licensed professionals.

All opinions are those of the seminar leader, and not of the MGMA or any other organization.

Financial Decision Models in an Era of Reform

Questions are welcome. If I cannot answer your question during the program because it is too long or too complex I will be glad to discuss it after the program, or after the conference.

Follow up questions via email are welcome.

Financial Decision Models in an Era of Reform

Please do NOT compare your practice to any of the numbers in this presentation.

The numbers used in the illustrations intentionally do not match any practice or specialty.

Please focus on the techniques, not the numbers.

Financial Decision Models in an Era of Reform

Learning Objectives:

Participants will be able to:

• Determine the impact of reform on group practice economics.

• Apply tools for making critical decisions about your practice’s future.

• Predict bottom-line sensitivity analysis and scenario modeling.

Financial Decision Models in an Era of Reform

Reform:

As this program is written health care reform is a hot topic in Washington and around the country. We will take some time to consider the updates before proceeding. Most of the material in this program is useful under any reform scenario.

Financial Decision Models in an Era of Reform

What if there is no reform?Not to worry….

These financial modeling techniques work well at any time, as the techniques are designed to improve decision making in any business environment.

Financial Decision Models in an Era of Reform

Reform:

Reform could be changing:• patient mix• payer mix and amounts per procedure• volume• ancillary revenues (number and fee structure)• relationship with the hospital and other providers• physician practice patterns• physician referral patterns

Financial Decision Models in an Era of Reform

Faulty (but common) Analysis

Total Group Expensesdivided by

Total Patient Encounters

equals

“Cost per Visit”

Financial Decision Models in an Era of Reform

$5,000,000 expenses

divided by

50,000 encounters

equals

$100 incremental per office visit

Financial Decision Models in an Era of Reform

So

“We lose money on any encounter paying less than $100 for the encounter.”

N0!

Financial Decision Models in an Era of Reform

The results - bad analysis

"Doctors say the state-set reimbursement rates are already too low, in some cases covering only one-third of the actual costs of patient visits."

Detroit News June 8, 2009

Financial Decision Models in an Era of Reform

"Doctors say the state-set reimbursement rates are already too low, insome cases covering only one-third of the actual costs of patient visits."

Detroit News June 8, 2009

While the reimbursement are decidedly too low, the cost analysis is faulty.

Incremental cost per visit is the key, and understanding cost behavior is the key to incremental cost.

Financial Decision Models in an Era of Reform

• Within a normal relevant range most costs are fixed within a given year.

• Variable costs (with some exceptions) tend to be low per encounter

• Physicians have varying levels of understanding how this impacts the bottom line

Financial Decision Models in an Era of Reform

Cost Definitions

Fixed Costs - unchanged by volume within a relevant range

administrator’s salary office lease

Variable costs - changes with each unit of some activity

casting suppliesinjectibles

Financial Decision Models in an Era of Reform

(cont.)

Mixed cost - a fixed component and a variable component

a copier lease with a per copy charge over ___

Step cost - additional cost incurred every ____ units

adding a rad tech every ___ in x-rays

Financial Decision Models in an Era of Reform

Understanding the cost behaviors is critical to proper decision making and proper analysis

Once the doors are open, most of the costs are fixed

Increase in volume does not drive an identical increase in costs

Financial Decision Models in an Era of Reform

Physician groups generally do not make good use of cost-volume-profit analysis

Many physicians have an intuitive understanding of cost behaviors, but need better information to support decisions

Financial Decision Models in an Era of Reform

The standard financial statement from your CPA in GAAP format is not very helpful in analysis or decision making.

You need more!

Financial Decision Models in an Era of Reform

Step #1

Contribution Margin

Collected revenueminus Variable costs

Equals Contribution Margin

Financial Decision Models in an Era of Reform

This allows

Collected revenueminus Variable costs

Equals Contribution Marginminus Fix Costs

Equals Net Income

Financial Decision Models in an Era of Reform

Private Medicare Medicaid“Public” *

Revenue 100 65 35 72

Variable 15 15 15 15

Margin 85 50 20 57

* current Medicare + 10% (proposal)

Financial Decision Models in an Era of Reform

Clearly we prefer private pay patients.

If we cannot fill the practice with private pay, the we have to deal with “patient mix.”

How will reform change the patient mix?

Financial Decision Models in an Era of Reform

Special situationsmulti-specialty groupsgroup providing heavy ancillary services affiliated surgery center or office surgerygeriatrics (heavy Medicare)urban (heavy Medicaid)poor economy area (Michigan)heavy “public plan” area (if there is a public plan)

Financial Decision Models in an Era of Reform

Each special situation requires a sophisticated financial model, such as:

• “product line” revenue tracking, product line contribution margins

• ancillary contribution margin keyed to office volume

Financial Decision Models in an Era of Reform

Budget model

This environment requires a sophisticated flexible budget model.

A budget IS NOT an accounting process.

Financial Decision Models in an Era of Reform

BUDGET

A management plan expressed in numbers, a decision process requiring a review of every revenue and expense, their behavior, and relationships to other revenues and costs.

Financial Decision Models in an Era of Reform

Static budget - a budget calculated for a single point - for example - 10,000 office calls

Flexible budget - a model built to calculate costs within a likely range - 9000 to 11000

Target - the most likely point within the range, say 10,500 office calls

Financial Decision Models in an Era of Reform

Capital budgeting, especially with regard to ancillary services, will require new modeling and new thinking. Adding services will not be an automatic route (it never really was) to increased physician compensation.

Financial Decision Models in an Era of Reform

Sensitivity Analysis

Measuring the change in contribution margin and net income from the change of a single variable

For example: Medicare fees drop by 20%

Financial Decision Models in an Era of Reform

Scenario Analysis

Multiple variables change, we project the results of a new scenario

For example: new patients are added with “public plan” insurance, there is a drop in Medicaid patients, Medicare fees drop 10%

Financial Decision Models in an Era of Reform

The capability to use either sensitivity analysis or scenario analysis is dependant on developing a contribution format statement.

If you do not understand your cost behavior you cannot correctly calculate the changes.

Financial Decision Models in an Era of Reform

Reform is likely to involve changes in• Patient mix• Payer rates• Covered services (plus and minus)• Ancillary utilization and payment

The ability to project the bottom line impact of these changes will be crucial to the group.

Financial Decision Models in an Era of Reform

• develop scenario analysis capabilities• calculate changes in

– patient mix– payer contract terms – additional providers, retired providers– additional ancillaries– new facilities– add mid-level services

Financial Decision Models in an Era of Reform

Groups should design sophisticated budget models in spreadsheet form in order to do scenario analysis quickly, and to do the analysis multiple times.

Lack the spreadsheet skills? Hire an accounting major from a local college.

Financial Decision Models in an Era of Reform

Keep in mind:

Relevance – only the revenues and expenses that change (+/-) are truly relevant to decisions

Relevant range – from the lowest number you can stay in business to the highest number of services you can provide – your capacity

Sunk costs – if you already spent the money or made a commitment, it is usually irrelevant to future decisions

Financial Decision Models in an Era of Reform

At this point let’s talk about what we know TODAY about the “reform” plan, future reform plans, failed reform plans and the impact on physicians, and how to build appropriate budget and scenario models.

Financial Decision Models in an Era of Reform

More resources

Cost Accounting: A Managerial Emphasis, 13th Edition by Charles T. Horngren, George Foster, Srikant M. Datar, and Madhav Rajan (Hardcover - Mar 14, 2008)

Managerial Accounting by Ray Garrison, Eric Noreen, and Peter Brewer (Hardcover - Feb 20, 2007)

(available at college libraries and at on-line book stores)

Financial Decision Models in an Era of Reform

More….

“How You Can Model Financial Uncertainty in Anticipation of Health Care Reform,” MGMA Connexion, February 2009, Tom Ealey

“A Framework for Cost Management and Decision Support Across Health Care Organizations of Varying Size and Scope,” The Journal of Health Care Finance, V. 35, No.2

Kevin Devine Ph.D., Xavier UniversityPriscilla O’Clock, Ph.D. CPA, Xavier UniversityTom Ealey, MA, CPA, Alma College

Financial Decision Models in an Era of Reform

Thank you to the staff of the Medical Group Management Association for their fine work and support.

Seminar Leader

Tom Ealey has three decades of experience in health care,including work as a CPA, management consultant, practiceadministrator, writer, seminar leader and litigation analyst.

Tom is an associate professor business administration at Alma College in Alma Michigan.

Contact: ealey@alma.edu or (989) 463-7135

Tom comments on practice management topics at:http://practicemanagementnews.blogspot.com