With So Much Uncertainty, How Do You Build Your Hospital’s Budget?

Many hospital CFOs have been in the planning mode going into the New Year, putting the finishing touches on their budgets. And some are hoping 2017 will be different from recent years. Despite average margins being up overall, some hospitals have found it harder to hit their annual budgets.

For example, one Midwestern health system recently ended its first quarter with a $10 million negative variance to budget. The system has enough cash flow to maintain overall profitability for now, but certainly cannot withstand that same deficit over multiple quarters. This reflects a recent and precarious trend we are seeing: hospitals that are profitable yet are missing budget targets.

One of my colleagues, Sean Angert, a senior vice president at Advisory Board, recently shared with me his perspective on this trend, which he has gained during his years working with hospitals on efforts to balance revenues with expenses. Angert’s insights speak to the concerns of today’s healthcare CFO regarding margin sustainability and planning for 2017.

Why Managing to a Budget Is Different Today

“There’s no question that budgeting is a lot more complex than it used to be when I first started almost 30 years ago—or even five years ago,” Angert says. “We’re in a whole new world, where hospitals have much less control over certain factors that impact performance and the overall budget, including volumes and expenses.” He notes, for example, that volume projections are less steady with the trend toward high-deductible plans, in part because many consumers will delay or avoid care that would have previously been delivered. And regarding expenses, he observes that, as healthier patients are directed to lower-cost sites, hospitals are seeing an increase in the average severity of their patients’ conditions, requiring them to deliver more costly acute care

“Such circumstances are making revenue and expenses increasingly less predictable and requiring more unplanned investments throughout the year,” Angert says. “While hospital leaders used to have the luxury of projecting their finances—and managing to a set annual budget—that approach no longer works in today’s environment. That’s why many of them are moving to flexible budgets that accommodate inevitable variances in volume, case mix, and unplanned expenses.”

More Costly Inpatient Care

When asked to elaborate on why it’s so hard to make yesterday’s assumptions about today’s budget, Angert underscores the fact that the average patient in the hospital today is increasingly sicker with more complications. (Advisory Board has tracked a 3 percent year-over-year increase in overall patient severity, nationally.) Such patients require a more involved and customized care plan to manage comorbidities—diabetes, anemia, coronary artery disease, and others.  

As a result of the increasing mix of these patients in many hospitals, there are many more cost and clinical outlier cases, which may not be accounted for in the historical budget, Angert says. He also points to the prevalence of pay-for-performance penalties—for hospital-acquired conditions and readmissions—as a factor further complicating the planning process.

Updating Cost Control Strategies

Cost control is obviously a big piece of ultimately making budget, and Angert has a clear perspective on the challenges hospitals face today in their efforts to curb expenses. “Whether it’s with labor, supplies, drugs or other categories, hospital leaders say that they have less wiggle room to improve efficiency,” he says. “For example, many have already tightened up productivity targets so often that staffing levels are generally efficient and lean. So where do they go from here?”

Angert suggests that instead of continuing to make cuts here and there for short-term budget needs, hospital leaders should look at the same issues from a slightly different lens. “For example, some take a more creative approach to workforce management—which has always been the biggest line item in the hospital budget,” he says.

He lists the following types of questions leaders can ask:

• Are clinical staff working at their top-of-license or is there room to improve?
• Does the hospital staff have flexibility to expand at peak times and right-size as needed?
• Is the annual budget set in stone or are there opportunities to be flexible on a monthly or quarterly basis, based on actual volume and demand?

Message for CFOs

Angert suggests that one of the biggest takeaways for CFOs is the importance of maintaining flexibility. He shares an example of one health system that lacked budgetary flexibility but realized that this caused a lot of unnecessary inefficiencies that are just not sustainable in today’s environment. “Across the organization’s multiple facilities, there were set levels of staffing in the budget that did not adjust based on service demands—resulting in both over- and under-staffed periods of time. But the system worked to design a flexible workforce budget and structure, and was able to take advantage of opportunities for sharing staff, adapting roles, and appropriately meeting demand.”

Many organizations like that health system are moving to a more flexible budget, Angert says. He notes that, based on actual volumes and spending over a given month or quarter, these organizations leave room to make adjustments to the budget and their projections. And best practice finance teams form a committee to meet regularly and discuss budget variances and how to close any gaps.

Angert’s message for hospital CFOs: With less predictability than ever, hospitals need to take a fundamentally different approach to budget planning so they can develop more accurate, yet flexible, projections. Because in many cases, experiencing one or two bad quarters puts a severe strain on even high-margin organizations (and their employee profit-sharing plans) and will raise serious questions from the board of directors.

John Johnston, CPA, MHA, is senior vice president at Advisory Board, Washington, D.C.