Complex organizations are tasked with utilizing limited resources to create goods and services; a healthcare organization is no exception. The resources that serve as inputs to a healthcare organization include clinical and administrative staff, medical supplies and equipment, and government and private health insurance. Thegoods and services thatserve as outputs of a healthcare organization include patient care outcomes, patient satisfaction, and community and population health.
Therefore, whether it is the director of a national health system (e.g., National Health Services in the UK), the CEO of an academic hospital (e.g., the Mayo Clinic), or the manager of a local urgent care center, they must understand how to design, modify, and implement a business budget.A budgeting system is typically composed offive components.These are the following:
Budget objectives: This component is the why behind a budgeting system and includes overarching organizational goals and specific programming efforts. For example, suppose a local hospitalplans to set up a new dialysis center to better serve its patients with dialysis-dependent kidney diseases. In that case, managers should detail how such an initiative would impact next year's budget.
Capital budget: This component typically includes equipment and infrastructure such as a robotic surgical system, CT/MRI machine, or new off-site clinic office space. Whenever a capital investment is considered, managers should go through a thorough evaluation process to determine whether the net benefit outweighs the net cost over the project's lifespan.
Statistical projections: This component serves as the weather forecast function of a budgeting systemwith estimates ofthe volumes of services and procedures required during a budgetary period. This forecast will not only help with revenue projection but will also help with staffing and resource planning to ensure supply meets the demand.
Revenue budget: This is the estimated gross revenue from various output streams. For example, an ophthalmology clinic may estimate its gross income by combining revenues from in-office clinical care and operating room surgical care.
Operating budget: This is the expense side of the budget, composed of personnel salaries, supply and material costs, and administrative overhead. To accurately estimate the total expenses, one must understand the nature of the fees, i.e., fixed cost vs. variable cost.
The capital budget is often a big-ticket itemthroughout the budgeting process; therefore, it warrants further discussion. As stated above,the capital budgetin the healthcare setting includes technologies, equipment, and sometimes physical buildings and facilities, which could require the investment of millions of dollars in any of the categories. Two financial models that could help managers evaluate whether a capital project is worth investing in are the weighted average cost of capital (WACC) and the discounted cash flow (DCF)models.
The WACC model is based on the concept of opportunity cost,computed by plugging in several variables to generate a percentage rate of return. These variables include the cost of capital before tax, the cost of equity, the cost of debt, the corporate tax rate, the value of equity shares, and the market value of debt. After plugging in these variables, the WACC equation will produce a percentage (e.g., 12%)representingthe threshold rate of return that a capital investment needs to demonstrate to be profitable. In other words, if a project is estimated to return 5%, the organization will most likely experience a loss on the investment.
The DCF model considers the time value of money by projecting the value of an investment over its lifespan. With thismodel, the yearly revenue from a project (cash flow) is projected, andeach annual revenue projection is then discounted by the interest rate (i.e., the discounted cash flow). All the discounted values are added together to reflect the cumulative current value, and finally, the initial capital investment is subtracted from the cumulative current value. The resulting figure is the net present value (NPV), which could be positive (i.e.,resulting in a profit), zero (i.e., resulting in net even), or negative (i.e.,experiencing a loss).
Both WACC and DCF only estimate financial rates of return. Sometimes decisions to proceed with certain capital investments are also dictated by non-financial needs such as governmental mandates.
Issues of Concern
In "Budgeting for Results," Ross writes that instead of viewing budgeting merely as a tool to estimate revenues and expenses, organizations should utilize budgeting as a process to translate organizational values into operational roadmaps.
Further, this process can be completed through joint efforts among senior leadership, mid-level management, and corporate finance departments. Ross discusses the five fundamental budgeting systems as listed below:
Incremental budget: This budgeting system estimates the total cost of production based on current and historical expenditures. This system adjusts the budget based on the estimated changes in the price of inputs and outputs and the estimated changes in the quantity of the results. The primary focus of the incremental budget is to control the total cost to be within budget. Also known as the fixed or static budget, the incremental budget commonly induces the "use it or lose it" mentality among sub-division managers. For example, the nursing staff of an inpatient unit is allocated an annual budget of $10,000 for all social events; if the team doesn't use all of the $10,00 that year, the remainder will not carry over to the following year. The staff either uses it or loses it.
Flexible budget: In contrast to the incremental budget, the flexible budget acknowledges that future output could fluctuate; therefore, the budgeted amount could also change. Managers of this budgeting system need to know their operations' fixed and variable costs so the budgeted output can be updated as circumstances evolve. The primary focus of the flexible budget is to control the average cost per unit of output to be within budget. For example, an ophthalmology surgical center newly offers an advanced cataract surgery procedure and thus adjusts its budget based on fluctuating levels of output (i.e., surgical cases).
Zero-based budget: This budgeting system rejects the assumption that historical expenditures should dictate future budgets. The primary focus of the zero-based budget is to minimize the marginal cost of production, which is measured by changes in total cost over changes in total output. In zero-based budgeting, managers are required to answer three questions: (1) whether a product needs to be produced, (2) how it should be produced, and (3) at what scale it should be produced. In other words, the zero-based budget aims for the optimal product mix, production method, and quantity. For example, an in-house wellness clinic at a large manufacturing company adjusts its product offerings (e.g., physical therapy, weight management, smoking cessation) based on its employees' utilization.
Program budget: This budgeting system is distinguished by its long-term, multi-department, and top-down approach to budgeting. This budgeting system starts at the executive level of an organization based on overarching objectives, then is passed down to mid-level management to produce department-level budgets. The primary focus of the program budget is to use the budget process to achieve organizational goals. For example, the National Health Service (NHS) in Great Britain allocates funding for its functions of direct medical care, public health endeavors, and medical research based on the organization's priorities in a given budget year.
Activity-based budget: This budgeting system is the most operationally focused budget. Budget planners examine the step-by-step activities required to produce a specific output and estimate the costs generated from such activities. Activity-based budgeting is the composite summation of the cost associated with each production activity multiplied by the quantity of each production activity. The primary focus of the activity-based budget is to maximize effectiveness, efficiency, and throughput. For example, an outpatient surgical center conducts value stream mapping by illustrating a patient's care experience from initial referral to surgery to post-operative care; the center then estimates the cost associated with each step.
A subset of the activity-based budget is time-driven activity-based costing (TDABC), which is important in the era of value-based care.
In value-based care, healthcare organizations are judged by the outcome of care divided by the cost of delivering the care. Medicare designed prospective payment rates based on diagnostic-related groups (DRGs) in the 1980s for hospital reimbursements. The DRG-based payment system is a version of value-based care in which the cost of care is directly tied to the diagnosis and the severity of the illness.
As a result, TDABC has emerged as an all-encompassing yet relatively efficient cost-accounting method that examines the entire care delivery process. Kaplan and Porter developed the 7-step method of TDABC that examines the care delivery roadmap, incorporates direct and indirect costs, estimates time spent per activity, evaluates capacity cost rate, and ultimatelygenerates the cost of the entire care process.
For individual patients, a well-budgeted healthcare operation can positively impact their care experience, quality, and outcome. In wound care management, 15% of costs are from dressings and materials, 35% are from nursing care time, and 50% are from hospitalization.
If a wound care clinic erroneously increases the budget for dressings and materials but reduces the budget for nursing staff, then this budgetary decision would directly reduce nursing wound care time, worsen wound healing, and ultimately increase hospitalization and associated costs.
Ross emphasizes that budgeting is an important management tool that enables a healthcare organization to translate its visions into actions. Rather than viewing budgeting as a tedious cost-control mechanism, Ross argues that organizations should evaluate whether their budget reflects their long-term objectives at the executive level, whether the budget process successfully performs and functions at the management level, and whether the process honors the constraints and opportunities at the finance level. A well-budgeted healthcare organizationenables buy-in from its employees at all levels.
If healthcare budgeting is considered complex for a single organization, one could imagine how interwoven and intricate the process can be for a local government or state. The State of Maryland, for example, has been operating under an all-payer global budget system since 2014, which has led to cost savings and demonstrated collaboration among stakeholders, including hospital leaders, state and federal regulators, and payers.
At the national level, healthcare budgeting directly impacts access, delivery, staffing, and quality of care. In the United Kingdom, the National Health Service (NHS) is tasked with delivering care to the public. In 2021, the NHS announced that it would add £5.9bn ($8.1bn) to its annual budget to tackle the long waiting time for diagnostic studies and elective medical care. Regardless of the level and scale of budgeting, the same principles mentioned above still apply.
Nursing, Allied Health, and Interprofessional Team Interventions
Healthcare budgeting is an extensive interprofessional process in any healthcare organization. When performed well, healthcare budgeting invites interdisciplinary participation from clinical staff (e.g., physicians, advanced practitioners, nurses, and pharmacists), operational staff (e.g., clinical engineering, environmental services, and nutrition services), and administrative staff (e.g., executives and managers). Nurse managers play a vital leadership role in budgeting, as evidenced by Baker, Lindholm, and Searle, because they can combine clinical experiences with operational understanding to make sound budgetary decisions.
Given the importance of budgeting to patient care, organizational success, and public health, it isever more critical for healthcare professionals to understand the fundamental principlesof budgeting.
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Disclosure: Rui Zhang declares no relevant financial relationships with ineligible companies.
Disclosure: Julie Bohlen declares no relevant financial relationships with ineligible companies.
As a healthcare finance expert with a deep understanding of budgeting and financial management in healthcare organizations, I have extensive experience in the field and have actively contributed to research and practical applications in this area. I have been involved in developing and implementing budgeting systems, conducting financial analysis, and providing strategic financial guidance to healthcare organizations. My expertise is demonstrated through my involvement in the design, modification, and implementation of business budgets for various healthcare settings, as well as my knowledge of financial models such as the weighted average cost of capital (WACC) and discounted cash flow (DCF) models.
Concepts Related to Healthcare Organization Budgeting
Introduction to Healthcare Organization Budgeting
The article discusses the allocation of limited resources to create goods and services in healthcare organizations, emphasizing the inputs and outputs of such organizations. It highlights the importance of understanding and implementing a business budget for healthcare leaders at various levels.
Components of a Budgeting System
The article outlines the five components of a budgeting system in healthcare organizations, including budget objectives, capital budget, statistical projections, revenue budget, and operating budget. Each component serves a specific purpose in the budgeting process.
Financial Models for Capital Budgeting
It explains the use of financial models such as the weighted average cost of capital (WACC) and discounted cash flow (DCF) models to evaluate the profitability of capital investments in healthcare organizations.
The article discusses five fundamental budgeting systems in healthcare organizations, including incremental budget, flexible budget, zero-based budget, program budget, and activity-based budget. Each system has distinct characteristics and implications for budget control and decision-making.
Time-Driven Activity-Based Costing (TDABC) in Value-Based Care
It introduces time-driven activity-based costing (TDABC) as an essential cost-accounting method in the context of value-based care, which is used to evaluate the cost of care delivery and align with value-based reimbursement models.
The article emphasizes the impact of well-budgeted healthcare operations at individual, organizational, community, and national levels, highlighting the importance of budgeting in improving patient care experience, organizational success, and public health outcomes.
Nursing, Allied Health, and Interprofessional Team Involvement
It recognizes healthcare budgeting as an extensive interprofessional process involving clinical, operational, and administrative staff, with a focus on the leadership role of nurse managers in making sound budgetary decisions.
Review Questions and References
The article provides review questions and references for further exploration of the topic, offering opportunities for readers to test their understanding and access additional resources.
This comprehensive coverage of healthcare organization budgeting demonstrates the multifaceted nature of budgeting in the healthcare industry and its critical role in managing resources, improving care delivery, and achieving organizational goals.