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How to Make Cost Accounting a Strategic Function

April 10, 2013

Jay Spence, our VP of Product & Industry Solutions, was recently featured HFMA’s April issue of Healthcare Cost Containment. His article “How to Make Cost Accounting a Strategic Function” is below.

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Healthcare Cost Containment, April 2013

As cost control becomes more critical for healthcare organizations, fine-tuning the cost accounting function has become a strategic necessity. Specific cost accounting strategies can yield more timely and accurate analysis that drives better bottom-line decisions.

Managing the cost of patient care is a top strategic priority of most hospital CFOs today. As advances in medicine enable hospitals to provide more effective and specialized care, the cost of care for human capital, administrative functions, new technologies, medical devices, and pharmaceuticals continues to outpace payment. Clear understanding of key volume, cost, and profitability measures across clinical service lines is becoming increasingly important for both long-range and tactical planning as well as data-driven decision making. Decisions related to strategic questions, such as which service lines to expand or which improvement opportunities could drive hard-dollar savings, require accurate and reliable patient-level cost and profitability analytics.

Strategies That Don’t Work – and Why

Many organizations struggle to produce accurate and timely views of service line volume, cost, and profitability metrics. Ineffective analytical approaches are a direct result of outdated technologies that are too complex and resource intensive to be efficient, too simplistic to meet an organization’s needs, or too inconsistent to be effective.

  • Detailed costing frameworks prove inefficient. Many healthcare organizations believe that highly detailed cost accounting systems would, by definition, produce more accurate results. These strategies are not effective because they emphasize collecting the most granular level of detail rather than identifying key cost drivers that are consistently captured on patient records – practical data that could actually support better business decisions.

    For example, breaking down a single activity by job class and by preparation, procedure, and post-procedure time estimates makes costing models difficult to change and maintain. Such models lack the flexibility to make needed changes, such as adding new procedures or revising or deleting other clinical processes. If costing models are not revised in a timely manner, the resulting cost and profit metrics are neither actionable nor valuable. Overwhelmed with unnecessary detail and trapped by rigid frameworks, clinically-focused decision makers find it difficult to use, much less trust, costing models and numbers.
  • Overly simplistic methods prove inaccurate. In stark contrast to highly detailed frameworks, some organizations use percent-of-charge methodologies that allow costing models to be developed at patient, procedure, or even service line levels. This is a highly efficient approach to establish proxy numbers for cost but lacks the detail needed to secure buy-in from clinical stakeholders, so the data are not used to identify true process-of-care differences or outliers that might influence the care delivery process – decisions that could have a bottom-line impact.
  • Inconsistent methods prove ineffective. Another common roadblock to the strategic use of costing data is the way information is disseminated to key stakeholders and decision makers after patient-level costs are assigned. For many, reconciling aggregated year-to-date patient-level volume, revenue, and cost data back to the financial statements is an important toll-gate prior to releasing data, and one that is difficult to produce. This is especially true if more complex patient cost assignments are done using standard costs, or using highly detailed, itemized, activity-driven methods with little tieback to actual expenses posted to monthly financials. Furthermore, because the decision sup-port function often becomes more reactive to ad hoc requests after all audits have been completed but does not provide the organization with ongoing views of performance reports, this information does not become part of the management framework to support decision making.

    Ultimately, cost accounting problems undermine trust in costing results. If key stakeholders don’t accept data as accurate, senior-level executives can’t rely on the information to make the strategic decisions necessary to control costs better or drive improvements in care delivery.

Successful Methodologies

Whether an organization is plagued with inefficient or inaccurate cost accounting and service line analytics tools and processes or is exploring a solution for the first time, the following practices, strategies, and techniques will help bring the cost accounting function to a more strategic level.

  • Structure a costing model that balances efficiency with accuracy. Hospitals are avoiding highly simplistic patient-level, ratio-of-cost-to-charge approaches in favor of more activity-based approaches. As a starting point, using the chargemaster as a proxy for activity drivers makes sense in a hospital setting because it is well understood by department managers and tracked consistently on patient records. Establishing costs at this level of detail provides an accurate representation of service utilization on a patient-by-patient basis.

    Another decision point is determining how to structure costs within the costing model. This is typically part of a mapping exercise where actual general ledger-level expenses are summarized into categories, or cost pools. However, the trend is to move away from highly summarized groupings (such as direct labor or direct supply) into more refined categories (such as patient care labor, implants, and drugs). This allows more precision during the next step—allocating and assigning costs from those cost pools to the charge item level, which is more broadly described as the relative-value-unit (RVU) development process, as shown in the exhibit above.
  • Refine activity-based costs with department manager input. It is vital for department managers to be engaged in the refinement of cost-per-test calculations for their areas. Manager participation promotes overall buy-in to the process. Also, a manager’s expert knowledge related to the delivery of patient care activities will, ultimately, improve the quality of the costs derived downstream at a patient level. This collaboration provides an opportunity to challenge the standard chargemaster as the best source of activity or detail. As an example, managers should take a closer look at nursing departments where a simple room-and-board charge may not accurately reflect the true care delivered patient-by-patient. Many organizations use acuity levels to properly capture the variation in resources required.

    Costing of medical supplies is another area where traditional RVU-based costing methodologies should be replaced with more refined direct costing methods. Service line managers are typically familiar with the source systems where this information is updated and stored, so automating ongoing item cost updates to the model streamlines the process and ensures accuracy.
  • Streamline data validation and reconciliation tasks. Gaining sign-off from finance on the validity of costing results is an important step in ensuring accuracy before rolling out monthly or quarterly reports to key stakeholders. This presentation should be an intuitive walk-through of financial results, starting with a consolidated income statement from the financials, footnoting any variances, and including consolidated patient-level costs. This dialogue with finance often uncovers areas and suggests methodologies for passing through specific revenues or overhead-related costs directly to specific patient populations. Given finance’s expanding role as a strategic business planning advisor, gaining this department’s confidence and trust in these numbers is important.
  • Provide timely and consistent views of service line performance. Once the patient-level database is audited, the information is ready for management use. However, all too often, the time and energy spent by the decision support team is allocated heavily toward preparing one-off ad hoc analysis. Instead, the team should make a concerted effort to be less reactive to ad hoc requests and more proactive with comprehensive views of volume, cost, and profitability trends across service lines. These reports should not be snapshot-focused on a single time period. Instead, they should provide year-over-year compar-isons with meaningful per-case and per-visit measures. Analysis should isolate the variables and drivers to changes in margin, including payer mix shifts, changes in net revenue per case, or increased supply costs. Lastly, the team should always interpret the data and offer up explanations to answer the “why” questions.
  • Assign accountability to clinical service lines. Even with a well-implemented costing methodology and effective reporting, many organizations fail to achieve value from their investment in decision support because no one owns the results. To ensure action is taken on opportunities identified, many organizations are structuring their businesses along clini-cal service lines. This helps foster a sense of ownership and accountability around service line performance and provides the executive attention and support needed to implement changes.

A Critical Success Factor

High-performing organizations are leveraging new technologies and implementing efficient and repeatable processes that can balance accuracy with efficiency so information is more timely and accurate. In light of pressures on hospitals to deliver and sustain healthy financial outcomes, having access to trusted service line cost and profitability analytics has never been more important. Adopting a more strategic approach to cost accounting is a critical success factor in today’s healthcare environment.