By Dan Topf
In the complex world of health care, effective budgeting is not just a financial necessity, it’s a lifeline. As Sr. Irene Kraus, a pioneering leader in hospital administration, famously said, “No margin, no mission.”
This powerful statement underscores the critical role that financial health plays in enabling health care organizations to fulfill their mission of providing quality patient care. Without a solid budget, even the most well-intentioned health care initiatives can falter, leaving patients and providers at risk
Budgeting is a critical component of financial management in health care organizations. It provides visibility to stakeholders inside and outside the organization, instilling confidence, especially among regulators and payors. A sound budget strategy offers insights into how the organization is performing as the period progresses, allowing for adjustments or the seizing of opportunities as they arise.
However, budgeting in health care is not without its challenges. Those who manage clinical or operations staff may lack experience with the financial side of the organization. Their lack of competence or confidence can influence their commitment to the budgeting process.
Additionally, organizational culture may encourage bad habits, such as inflating your estimates, or purposely low-balling costs, which can distort budget accuracy and reduce its usefulness.
Types of Budgeting Approaches
Two broad strategies are commonly used in health care budgeting: Zero-Based Budgeting (ZBB) and Incremental Budgeting (IB).
Zero-Based Budgeting requires starting from a “zero base” each budgeting period, justifying all expenses anew rather than basing them on previous budgets.
- Pros:
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- Cost Efficiency: Forces a thorough review of all expenses, potentially uncovering inefficiencies and reducing costs.
- Resource Allocation: Ensures resources are allocated based on current needs and priorities.
- Cons:
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- Time-Consuming: Can be resource-intensive and time-consuming to implement.
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- Short-Term Focus: May encourage short-term thinking over long-term planning.
Incremental Budgeting (IB) uses the previous period’s budget as a base, making only incremental changes for the new period.
- Pros:
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- Simplicity: Easy to implement and understand, requiring fewer calculations.
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- Stability: Provides consistency and stability in budgeting.
- Cons:
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- Inefficiency: May perpetuate inefficiencies by not critically evaluating all expenses.
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- Encourages Spending: Can lead to unnecessary spending to ensure future budget allocations.
A blended approach can combine the thoroughness of ZBB with the simplicity of IB. For example, use ZBB periodically to reassess and reset baseline expenses, while using IB for more routine, less critical budget adjustments.
Essential Budgeting Skills
Effective budgeting in health care requires several key skills. These are skills you may not have been exposed to in your health care training. That said, they can be developed with a bit of effort and focus:
Planning
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- Definition: Thinking through the implications of changes, activities, and other material efforts that require financial resources.
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- Importance: Effective planning ensures that all potential costs and impacts are considered, leading to more accurate and realistic budgets.
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- Scalable Targets: Incorporating scalable targets allows costs to grow or vary from the budget if the overall aims are achieved. For example, a Percentage Gross Margin improvement target means that costs may increase, but if revenues increase more, the organization can still achieve its financial goals.
Critical Thinking
- Definition: Converting the plans of higher-level administration into actionable plans at the division or department level.
- Importance: Critical thinking allows managers to align their departmental goals with the organization’s overall strategy, ensuring coherence and efficiency. For example, if we aspire to be “Your Mother’s Choice for Your Delivery,” a manager uses critical thinking to determine the best use of budget resources for concrete steps to achieve that aspiration.
Estimating
- Definition: Deriving close estimates or approximations of the financial implications of specific plans.
- Importance: Accurate estimating helps in setting realistic budgets and avoiding over- or under-allocation of resources.
Explaining
- Definition: Describing the rationale, assumptions, and estimating approach to others to engage them in implementing plans and evaluating their success.
- Importance: Clear communication fosters understanding and buy-in from stakeholders, which is crucial for successful budget implementation and monitoring.
Basics of Management Budgets
A management budget in health care is a financial plan that outlines the expected revenues and expenses for the day-to-day operations of a health care organization over a specific period, typically a quarter or a year. It includes costs related to staffing, supplies, utilities, and other operational expenses.
Some expenses are fixed or variable with patient volumes. A fixed expense may be rent, utilities, administrative staff, and the like that financial professionals consider “fixed.” The idea is that if more or less care procedures are delivered, these expenses stay the same. I’ll admit, in the long run all expenses are variable. Financial professionals are assuming here.
Variable expenses are hourly care-team time, medical supplies, consultations, diagnostics, and the like. These expenses typically increase when volumes increase. Knowing the difference between fixed and variable expenses is critical.
Often, health care leaders new to budgeting assume that any cost increase in a period is bad. Not when additional expense comes with even more revenue. When you understand when patient volumes are up, two things happen: expenses increase and so does revenue. If the revenue increases more than the variable expense, you will be successful.
Importance of Management Budgets
As Sr. Irene taught us, strong fiscal discipline is essential for the long-term sustainability of any health care provider. These disciplines provide tremendous benefits:
- Operational Efficiency: Helps ensure that resources are allocated efficiently to maintain smooth operations and high-quality patient care.
- Financial Control: Provides a framework for monitoring financial performance and adjusting as needed to stay within budget.
- Strategic Planning: Supports long-term strategic goals by aligning operational activities with the organization’s overall mission and objectives.
How Are Management Budgets Created?
Your health care organization will likely have a very specific timeline, process, and stakeholder group for creating management budgets. The process generally begins with a candid assessment of the previous few periods and a forecast of future financial possibilities, goals, and aims.
This discussion also includes prioritization and planning along with risks and opportunities. There are also a few universal steps:
- Revenue Estimation: Forecasting the expected income from various sources, such as patient services, insurance reimbursements, and grants.
- Expense Estimation: Identifying and estimating the costs associated with running the health care facility, including salaries, medical supplies, and administrative expenses.
- Budget Approval: Presenting the budget to senior management and stakeholders for review and approval.
- Implementation and Monitoring: Implementing the budget and regularly monitoring actual performance against the budget to identify variances and take corrective actions.
Analyzing Budget Outcomes
During the performance period (the month, quarter, or year) leaders will compare their budgeted results to actual results. A well-informed leader can put variances into context and determine what actions, if any, need to be taken.
A variance in and of itself is not a cause for concern. Informed leaders will assess the following before taking any action:
- Materiality: A variance is important to act on when it is material, meaning it significantly impacts the financial health or operational efficiency of the organization. Materiality thresholds can vary, but typically, a variance that exceeds a certain percentage of the budget (e.g., 5-10%) warrants attention. Further, if a variance is unexpected, or unplanned for, it may require adjustments in activities.
- Trends: Persistent variances over multiple periods indicate underlying issues that need to be addressed. For example, consistently higher-than-expected labor costs might suggest staffing inefficiencies or overtime issues.
- Impact on Patient Care: Variances that affect patient care quality or safety are critical to address immediately. For instance, a shortage in medical supplies due to budget variances can directly impact patient outcomes.
Types of Health Care Budget Variance Analysis
- Volume Variance: Refers to the difference between the expected and actual number of services provided or patients treated. This variance directly impacts revenue and resource allocation.
- Efficiency Variance: Measures the difference between the expected and actual use of resources, such as labor or supplies. High efficiency variances may indicate inefficiencies in operations.
- Price Variance: The difference between the budgeted and actual cost of resources. Significant price variances can indicate issues with supplier contracts or market price changes.
In the dynamic world of health care, a well-crafted budget is more than just a financial plan—it’s a strategic powerhouse. By mastering budgeting skills and approaches, health care leaders can turn financial challenges into opportunities, ensuring that every dollar spent drives innovation, enhances patient care, and secures a sustainable future.
Not sure where to start? Finance and Accounting for Non-Financial Professionals and Finance Fundamentals are great professional development programs that can help you establish the basic understanding of financial concepts and prepare you to make budget decisions that drive growth and financial performance at your organization.
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Dan Topf is a successful performance improvement consultant who is passionate about helping people and businesses achieve dramatic performance improvement through learning. Dan’s client list includes Accenture, Drake University, Sears, ING Group, ING Direct, PricewaterhouseCoopers, Wells Fargo, the Principal Financial Group, the Hartford Financial Services Group, GEA Group, Chubb, MetLife, Continental Western Group (a W.R. Berkley Corp.), CIGNA, the University of Iowa, and many more. Dan is a past president of the Golden Circle Chapter of the International Society for Performance Improvement (ISPI). Dan has been an adjunct lecturer at Drake University, and he has served as assistant director of the Executive M.B.A. Program in the Henry B. Tippie College of Business at the University of Iowa.