Budgeting & Quality Assurance
Risk management is a discipline devoted to the prevention of financial loss associated with various hazards: lightning striking the building, fires, floods, theft and embezzlement, and most important of all, lawyers. Reduced to its essentials for most health care organizations, risk management means avoiding financial loss due to lawsuit, since suits are more common than fire, flood or fiduciary impropriety. The first step in managing risk, as noted in the text (p. 482) is identifying and evaluating sources of risk. Risk can then be accepted, transferred, reduced, or eliminated.
Identifying risk through:
Evaluating again, through a mixture of experience and expert guidance.
A risk is "accepted" when the organization decides that it can bear any financial
cost associated with a particular risk. For example, a large corporation could self-insure against fire damages at any of its facilities; the Federal government does this. Thus, if fire damage occurs, the organization uses its own monies to pay for repairs. In general, however, few private institutions do this. As your text points out, a sensible institution cannot just decide to call itself self-insured; it will need actuarial studies to determine the true level of risk, financial resources set aside for this contingency, and so on.
A risk is transferred when it is placed on some other institution. Insurance is an example of risk transferral: For a fee, the insurance firm agrees to accept the financial risk associated with fire, flood, malpractice, or whatever. This is the most common method ? Probst, 2000 1
for handling risk. In the case noted in your text, subcontractors to the organization can sign "hold harmless" agreements, stating that they, not the health care organization, will bear the risk associated with errors made by the subcontractor's staff. In actuality, I am not sure such clauses are completely effective; the legal doctrine called "respondeat superior," through which the hospital can be sued for the actions of its employees, may have some applicability to contractors, particularly if the hospital assumes responsibility for ensuring the quality of contractor-provided services.
Reducing risk is an important component of risk management. Risk reduction is a task for the natural paranoiacs among us: reviewing every aspect of an institution to determine what could possibly go wrong. Some aspects of risk reduction are obvious extensions of natural hazards. Fire is a risk; the financial loss associated with fire can be reduced by installing smoke detectors and sprinkler systems. Loss of electric power is a risk; the dangers to patients and systems can be reduced by installing backup generators for use in an emergency. Sweeping leaves off the front step reduces the risk that an entering patient or visitor will slip and fall.
Some risks are specific to the process of care: medications are misadministered; restraints fail and patients fall out of bed; procedures are performed on the wrong patient. To monitor existing hazards systematically, allowing the eventual identification of systemic corrective actions, "occurrence reporting," as in the form on p. 485 of your text, is required in most health care institutions. The text does an interesting job of presenting the moral balancing act involved in occurrence reporting systems. The need for objective information that can be used for improvement, for example, must battle with the need medical professionals feel to safeguard themselves from what is perceived to be needless legal harassment.
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Risk reduction, defined as limiting financial damage to the health care organization, can include talking to the patient who has experienced an "occurrence" before the patient or his/her family have had the opportunity to seek legal counsel. Even RLD seem a little embarrassed about sending the institution's professionals up against the uneducated and presumably emotionally involved patient and family. At least they recommend honesty on the institution's part--but they end up justifying honesty not on ethical grounds, but because
fraud or misrepresentation by the risk manager . . . will cause a court to
set aside any agreement and may result in criminal charges or punitive
damages . . .(p. 485)"
(An aside: We tend to blame lawyers for malpractice suits. A study of pediatric malpractice suits published in JAMA showed that most families were not inspired to sue
by the recommendations of a lawyer. Most commonly, a second health care professional providing treatment at a later date reviewed the incident and spontaneously offered the opinion that malpractice had occurred.)
Finally, risk can be eliminated. The most common means of eliminating risk is to
eliminate the service that generates it. Obstetrics is a relatively low revenue, high risk area; so is pediatrics. The statute of limitations for injuries to an infant or child, for example, holds that he/she may sue at any time between the incident and the time he/she turns 21, making the risk period extremely lengthy. Many hospitals avoid the financial risk associated with these services by deciding not to offer them.
Risk can also be reduced, for a corporation, or eliminated, for an individual, by eliminating assets. The text notes that corporate restructuring can eliminate the risk to a parent corporation from the actions of its independent subsidiary, the hospital. (The plaintiff in a suit can only reach the hospital.) Physicians can avoid the risk of financial ? Probst, 2000 3
loss associated with their provision of services by "flying bare," refusing to carry malpractice insurance and placing all their financial assets in the hands of others, such as spouse or children. Elimination of risk in this fashion requires another ethical balancing act: between the need of the organization or individual to protect its/his assets and the need of the person who has been injured to receive just compensation.
Risk reduction, elimination and transfer are essential for any health services organization. Risk reduction in terms of appointing "safety officers" with fire fighting and police experience, use of industrial engineers to define hazardous processes, and similar positive prevention strategies have a long history in health institutions. But it is clear that health professionals are not comfortable with a concept of "risk reduction" that focuses on legal actions to minimize the financial consequences of error. "Quality assurance" has always seemed a more ethically sound means for assuring that both institution and patient benefit from a course of care.
The text discusses budgeting in the context of control: Chapter 12 is
entitled "Control, Risk Management, Quality Assessment/Improvement, and Resource
Allocation." There is perhaps a tendency to concentrate a bit too much on the control aspects of budgeting (e.g., I've got to stay in my budget!) and too little on the role of budgeting as a planning process (Are you "over" budget because you neglected to provide upper management with a correct statement of your anticipated expenses during the planning period?) Therefore, while we will discuss both functions of budgets in our discussion this afternoon, planning and control, we will spend a little more time on planning.
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1 Budgeting as a Tool for Planning
In Class Exercise #1: Link between budget and strategic planning. What should these people do?
The purpose of this outrageously simple situation was to illustrate the use of a
2budget as an instrument for strategic planning. This budget has been reduced to a set of
meaningful generics: not capital, personnel, and other sorts of money going in and out, but broad categories:
What comes in: Revenues. Revenues are the fuel that powers the rest of the
engine. If your organization does not anticipate people coming by to buy—inpatients,
outpatients, whatever—the rest is moot.
What goes out: Expenses, both operating and strategic. It is assumed that like a good manager, you are plowing some portion of profit back into your institution, making it effective over the long term by some sort of strategic investment: a new wing for cancer treatment, a new computer, whatever.
Under Plan 3, you essentially do nothing about the new revenue projections except take the hit: net profit is reduced. That may be the best action you can take if the revenue
1The following texts were reviewed in preparation for the budget portion of this series; some ideas may have slipped by without acknowledgment: Berman, H.J., Weeks, L.E. and Kukla, S.F. (1986) The Financial Management of Hospitals (Ann Arbor, MI: Health Administration Press). Hy, R.J. (1989)
Financial Management for Health Care Administrators (New York: Quorum Books). Ward, W.J., Jr.
(1988) An Introduction to Health Care Financial Management (Owings Mills, MD: National Health
Publishing). 2Table and idea sized from, but considerably embroidered upon, Asay, L.D. and Maciariello, J.A. (1991) Executive Leadership in Health Care (San Francisco: Jossey-Bass Publishers), Chapter 6, "Implementing Strategic Planning and Resource Allocation," p. 92
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shortfall is temporary: if, for example, revenue was down because one wing was closed while renovations took place. Revenue from that wing would return in future years, so no alteration in long term planning is needed.
If the revenue shortfall looks like the start of a trend rather than a temporary fluctuation, then management needs to do something. From a strategic perspective, reducing expenses (plan 2) is better than reducing strategic expenditures (plan 1). (Providing, of course, that you don't fall into the Strategic Management Trap, cutting costs in ways that also cut service quality). Strategic expenditures are your attempt to ensure that revenue shortfalls do not become chronic. If funding for new programs is reduced, you run the risk of worse revenue declines in the years ahead.
In working with a strategic budget, as our discussion has implied, you are considering actions over a multi-year period. (Remember, we had to consider whether the
revenue shortfall was a one-time or a repeated event, and consider its effects on the years to come as well as the year being budgeted). Further, you are using the allocation of monies to put into effect the current strategic plan of the organization. Budgeting is
essential for keeping track of things, which is the use to which we are accustomed, but in addition a budget is the concrete expression of your strategic philosophy. (slide 2)
3 Outpatient Clinic. What level of visits should be anticipated In-class Exercise 2:
and planned for?
3Taken from Ward, op cit, p. 92. This book is an excellent primer on financial management: clear, concise and enjoyable to read.
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Two points about operational budgeting flow from this exercise. First, this budget has no dollar values attached. It is a budget for services you intend to provide. Without an estimate of workload, you cannot prepare an operational budget. Workload, or volume,
estimates begin with the amount of work (services, procedures, pounds of laundry washed, square feet of floor vacuumed) you anticipate during the coming year. Easy enough. Anticipated volume of work, coupled with anticipated payment for that volume, drives the staff you will be able to hire, the supplies you will be able to use, and so on. The second point is similar, but retrospective: without workload data, you cannot assess budget performance. Just looking to see if a particular department is over or under budget is not adequate; one has to view expenditures in light of activity. (repeat: this is a hint)
4 Putting together an operations budget is a sequential process: (Slide 3)
Statement of goals and objectives: Goals and objectives form your mantra, the
prayer that should be repeated before the process of budgeting is begun. Even if you are preparing the laundry budget, you must keep in mind the laundry's role in advancing the institution's goals. It is really easy to forget that all organization members are supposed to be members of the same team when squabbling over whose capital improvement project will be funded this year.
Volume budget: If your volumes are independent of those in other parts of an organization, preparing a volume budget is an easy task. The second in-class exercise dealt with this situation. If your volumes are dependent on volumes elsewhere in the institution, as for example a laboratory, you will need to get volume estimates from the department heads. A laboratory director, for example, could prepare next year's budget by examining this year's workload and adding a percentage for increase. However, because different units within the hospital have different levels of demand for laboratory services,
4Discussion from Ward, op cit, Chapter 5, "Operations Budgeting."
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one that separately tallied Medical, Surgical, Pediatrics, Obstetrics and Intensive Care (ICU) would be more effective. If the obstetrics unit, which accounts for 5% of your workload, expands by 10%, this might lead to a 0.5% increase in your workload. Failure to coordinate with obstetrics will lead to an error that is embarassing, but not catastrophic. The Medical wards, on the other hand, might account for 50% of your total procedures. A 10% decrease in Medical orders because of change in reimbursement will mean a 5% drop in revenues in your department. If that change means that you don't get a volume of business sufficient to pay for current staff, you have a serious problem.
Revenue budget; This is fairly self-evident. Once you know how many units of
each type of service you intend to provide, you multiply units by applicable prices to see the revenue that will be generated. Billing units are various: for board in the hospital, days; for clinics, visits; for operating room or anestheiology, minutes; for blood bank, 500 cc units; and so on.
Personnel budget: Given existing productivity levels, how many people will be
needed during the year being planned? If volume and thus revenue are anticipated to decrease, how will this be handled? Is turnover alone enough to provide requisite savings? Will the market bear a price increase, allowing you to retain present staff?
Supplies and services budget: Your budget for supplied and services will probably
be a mixture of fixed costs (e.g., payments for purchase or lease of equipment) and variable costs. Variable costs are tied to your patient volume: e.g., number of syringes or bandages or whatever.
Types of Budgets:
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It is appropriate about now to back up a bit. We have noted that budgets are used for both strategic and operational purposes, and that budgets and budget analysis can include both dollars and commodities. Most large institutions will have three types of budget:
Operating (revenue and expense) The operating budget has just been briefly
discussed. Based on the volume of services expected to be delivered, projections for revenue and thus for allowable expenses are prepared.
There is a difference between fixed and variable costs in your operating budget. Items that remain constant over time, cannot be quickly changed, and do not vary with changes in patient volume are referred to as "fixed" costs. The cost of a head nurse and a staff secretary for each ward, for example, would not vary with the number of patients on the ward. The cost of meals delivered to the ward, on the other hand, varies directly with the number of patients: the more patients, the more meals. Costs and rise and fall with activity levels are referred to as "variable" costs. In the long run, of course, even "fixed" costs can be changed.
Capital. The capital budget deals with "capital" investments: things like equipment, buildings, and so on that have both high initial costs and a potentially long life span. Part of your capital budget might be retiring the mortgage on your building. Part of it might be a "sinking fund": dollars you allocate each year against future expenditures.
You should be familir with something called "generally acceptable accounting techniques." When publicly owned (e.g., stockholder owned) institutions formulate a budget, they are expected to develop distinct operational and capital budgets. Once monies have been allocated, they don't easily change. Why? A responsible organization ? Probst, 2000 9
plans both for its day to day activities (operational) and for the eventual replacement of its plant and equipment (capital). The relative size of the capital budget is an indication of the financial stability of the organization. An irresponsible organization might attempt to conceal its true financial status by publishing a nice capital budget, but then dipping into capital funds to underwrite operational losses--perhaps even to hide them. Accountants take a dim view of this sort of thing.
Cash. Finally, each organization has a "cash" budget, which is roughly analogous to your checkbook. The cash budget compares anticipated inflow each month (people paying you what they owe) to anticipated outflow (you paying other folks what you owe them). This allows the organization to anticipate shortfalls in inflow and arrange a line of credit to cover those periods. For example, when a new wing in a hospital is opened, patients come in immediately and nursing staff, dietary staff, and so on to serve them must be provided--and paid--immediately. Payment from those patients, however, can be delayed for months as insurers work through the paperwork. To cover the gap between the time when the organization must pay for its resource and the time the organization receives payment from patients, the organization might use credit. Alternatively, money could have been set aside prior to the opening for this purpose. (The smaller the gap between service delivery and receipt of payment, the better. Hence the popularity of electronic bill filing.) In any case, the purpose of the cash budget is to ensure that the organization doesn't bounce its checks. (Kappa bouncing story.)
Operating, capital and cash budgets are all interrelated, making the process of
5) arriving at all three of them iterative. (discuss slide
5Ward, op cit, p. 74.
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