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Hospital finance: a primer for the Wannabe’ lab managers
The cornerstone to any successful business is its financial structure. The concept is no different for hospital laboratories than for other businesses. Most laboratorians, however, did not enter the field of laboratory medicine with the idea of becoming a financial manager. But in today’s cost conscious hospital environment, running an efficient business is essential for the survival of both the laboratory and its manager - and successful lab managers know how to prepare accurate budgets. What follows is the “how to” of the budgeting process, which Has three major components:. 1. determining anticipated workload; 2.costing out the product; and 3.justifying capital needs .
Workload determination
Laboratorians are really in the answer business. Consider glucose as our subject. The physician asks: “What is the glucose value in this patient?” The laboratorian answers: “100 mg/dL.” In order to prepare an accurate budget, a lab manager needs to know how many “answers” his lab will need to produce in the coming fiscal year. In a hospital, the lab manager must know his lab’s anticipated workload. These figures usually come from the hospital’s finance department, which can provide an assumption for the number of patient days for the new fiscal year as well as a historical perspective on required lab testing per patient day.With this information, the lab manager can develop production estimates. If the lab conducts outreach, the manager should utilize the lab’s historical data - while making adjustments based on input from the marketing/sales department regarding winning,losing, and retaining clients. The same applies to the lab’s out-patient workload, except that the keeper of this information isagain the hospital’s finance department.Having analyzed all of this historical data, the lab manager can now determine his lab’s workload for the new fiscal year. This assumes, of course, that he knows the information supplied from both the hospital’s finance department and his own outreach department is accurate and valid. By knowing what has happened in past years, he should be able to determine whether the data is an understatement or an overstatement and whether he needs to make adjustments.
Accurately cost out lab product The lab manager’s next task is to cost out the production of this workload for the new fiscal year. To do this, he needs to
If the system works true to form, hospital administrators will likely ask the lab manager to trim some budget items.
understand what resources the lab will need and what those resources will cost. This is where cost-accounting tasks come into play. A lab manager needs to know exactly what is involved, for example, in producing a “glucose answer.” He must know: 1. How the doctor asks his question: on paper, by phone, or by computer. For his lab to answer a physician by any of these methods, he will need to spend money to obtain necessary resources such as front-office assistants and forms or computer personnel and hardware, or both. 2. How the sample is obtained from the patient. Does the lab supply the resource needed to obtain the sample, or does that resource come from nursing’s budget? Are materials such as vacutainers and needles supplied by the lab? If the lab supplies the labor and materials, the lab manager must include those costs in his calculation to determine the lab’s budget. 3. How the sample is transported to the lab. Is a pneumatic tube system available, or do phlebotomists transport the samples. Does the lab have to pay for maintenance costs for the pneumatic tube system? If so, the lab manager must factor in these costs. 4. Where the sample goes when it arrives in the lab. Does it go to a central preparation area? What are the resources needed to prepare the sample for analysis? Is it centrifuged down and poured off? What resources are needed in this area? Personnel, disposables, centrifuge maintenance, centrifuge equipment depreciation - all are part of the lab’s costs. 5. Who moves the sample from the central processing area. Does the central lab provide labor to transfer the sample to the lab doing the testing? How is the sample scheduled for testing? Is clerical work necessary before testing? All are part of the lab’s costs. 6. Before the lab runs the sample, someone needs to calibrate the analyzer and run the controls. This requires labor and materials. The lab manager must factor these expenses into product-cost calculations. 7. When the sample is ready to run on the analyzer, the lab must either use disposables or direct tube the sample. If disposables are used, the lab manager must gather and include these costs. 8. The testing equipment is either bought and depreciated or leased. What about these depreciation or leasing costs? The lab manager needs to include them, too. 9. The analyzer must be maintained. How is this handled? Is there a maintenance contract? Do lab personnel have to conduct periodic maintenance? He must include this resource utilization and any contract fees. 10. Someone usually reviews the results before they are released. This requires labor that the lab manager must account for in his budget. 11. The answer must be relayed to the doctor. By phone? By computer? On paper with delivery to the patient floors? Who pays for this? This lab labor is part of the budget. 12. Management keeps the organization functional. He must include these labor costs. 13. Labs often refer tests. He must budget this cost, too. 14. The lab manager will realize that he must include many other items in his lab’s cost structure. Other costs will include blood and blood products for blood bank, consultant and/or pathologist salaries, couriers and courier cars, travel, meetings, books, and regulatory fees. He must also include costs for such services as uniform laundry/dry cleaning. Payroll expenses will include deductions for Social Security (FICA) taxes and health insurance benefits. Overhead will include such items as rent, electricity, phone service, and security. In most hospitals, these are allocated expenses that are assigned to the laboratory by the finance department. The lab manager may want to further subdivide these categories:
In order to prepare the lab budget, a manager must add all of the previously mentioned items in each category that he anticipates spending. If the system works true to form,hospital administrators will likely ask the lab manager to trim some budget items.
Depreciation of lab equipment
There are usually two budgets produced in a hospital. One is for operational expenses - the essential items an organization must purchase to maintain its business (i.e., employees’ wages qualify here). The other is for capital expenses - those costs that will provide the organization with a long-term benefit. While not tax deductible as a business expense in one lump sum, capital costs may be depreciated or amortized. Depreciation is a term that denotes the fact that capital equipment ages and that a business must put aside funds to eventually replace it. If an analyzer costs $100,000, and the lab keeps it for five years, the yearly depreciation is calculated by dividing $100,000 by five, for a figure of $20,000. Every year, the lab manager must account for this expense and add the depreciation to his costs in order to bill enough to replace it. For example, he could add $0.40 to the cost of the lab’s 50,000 tests per year ($20,000 divided by 50,000) to recoup the initial cost of the analyzer.
In order to justify purchasing capital equipment for a hospital lab, a manager needs to prove that e ach piece of equipment he wants is an investment in the facility’s future.
If he wants, the lab manager could reduce this cost per test in two different ways. First, he could decide that the equipment will last longer than five years. For example, if he decides to keep the analyzer for seven years, he will have an annual depreciation of $14,386 ($100,000 divided by seven), and the cost per test would be $0.29 ($14,386 divided by 50,000). Second,he could run more samples through the analyzer every year. If the annual volume were 75,000, the cost per test would be reduced from $0.40 to $0.27. Unfortunately, most hospital labs have no certain method of attracting more business so the lab manager would have a hard time justifying a huge increase in tests.
Justify capital needs
In order to justify purchasing capital equipment for a hospital lab, a manager needs to prove that each piece of equipment he wants is an investment in the facility’s future. To evaluate such purchases, most institutions use a five-year pro-forma a financial model that compares the cost of the equipment to the revenue it will generate. In the case of a lab, the proforma would include all the expenses necessary to develop a product using the capital equipment as well as all the revenue generated by that product. The pro-forma is usually developed in a spreadsheet using software such as Excel. Specific financial terms used in a pro-forma include: • Discounted cash flows: This is the revenue generated each of the five years in the pro-forma. The revenue is reduced (discounted) by a number similar to the annual inflation rate called the discount rate. Since this rate is determined by a complex calculation, the hospital’s finance department will supply it to the lab manager. The rate takes into account interest rates and money lost to other investments by investing in the laboratory’s project. • Net present value or NPV: This is the sum of five years of discounted cash flows in the pro-forma minus the cost of the equipment. If this is a positive number, the hospital’s finance department will consider the investment valid. Still, this does not mean the hospital will approve the lab’s capital expenses because the lab is competing against other departments for the hospital’s capital dollars. • Payback period: This is the cost of an item divided by its annual generated revenue. This equals the number of years to pay back the investment. On a five-year pro-forma, the payback should occur in two to three years, usually not any longer. • Return on investment or ROI: This is the monies or percentage of gain earned on investment and is calculated by the following formula:
investment ROI = __________ -1 ∑ returns
100,000 ROI __________ -1=33% 150,000
• Internal rate of return or IRR: This is the discount rate that makes the NPV = $0.00. This is determined by computer since the answer is determined by iteration. This means that the lab manager keeps substituting numbers in the formula until he sees the NPV = $0.00. Excel does this automatically. • Hurdle rate: This is the minimum IRR required for funding a project. The hospital’s finance department will give this number to the lab manager. The hurdle rate is usually higher than the standard discount rate because the hospital’s finance department wants to make sure that if any of the lab’s revenue assumptions are not on target that there is a cushion to fall back on. The hospital then evaluates the lab manager’s investment request to see how it compares to the ROI from other departments and usually tries to select those investments that return the most revenue to the institution.
Strategic investments
The lab manager should understand that there are some capital items that he can never justify with a pro-forma. Instead, he should present these items as strategic investments for the institution. A lab makes strategic investments in order to remain competitive - even though the investment will not show a positive return. The hospital computer system is a good example of a strategic investment. If the hospital does not have a computer system, it cannot compete with the other hospitals in its region that have one. Doctors will not usually work at a hospital that does not have a computer system, and certain vendors will not sell products to a hospital that does not have one because of a requirement for automated purchasing systems. If hospital administrators try to justify a multimillion-dollar system with labor savings, they will never re-deploy enough people to justify the expense; but without a computer system, that hospital is out of business. The hospital must make this strategic investment. Evaluating laboratory finances is complex and challenging for the lab manager. With the right information processed in orderly steps, budgeting is, however, a completely manageable task. Laboratorians should stir up their appetite for financial management. Some hands-on classes can help them completely understand and master basic financial tools. And as a result of their newly acquired skills, they will become very successful lab managers
By Lawrence J. Crolla, PhD
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