Comparative data in healthcare organizations

Using Comparative Data 14

C H A P T E R

OVERVIEW

Comparative data can become an important tool for the manager. It is important, however, to fully understand the requirements and the uses of such data.

COMPARABILITY REQUIREMENTS

True comparability needs to meet three criteria: consis- tency, verification, and unit measurement. Each is dis- cussed in this section.

Consistency

Three equally important elements of consistency should be considered as follows.

Time Periods

Time periods should be consistent. For example, a ten- month period should not be compared to a twelve- month period. Instead, the ten-month period should be annualized, as described within this chapter.

Consistent Methodology

The same methods should be used across time periods. For example, Chapter 8 discusses the use of two inven- tory methods: first-in, first-out (FIFO) versus last-in, last- out (LIFO). The same inventory method—one or the other—should always be used consistently for both the beginning of the year and for the end of the year.

After completing this chapter, you should be able to

1. Understand the three criteria for true comparability.

2. Understand the four uses of comparative data.

3. Annualize partial-year expenses.

4. Apply inflation factors. 5. Understand basic currency

measures.

P r o g r e s s N o t e s

152 CHAPTER 14 Using Comparative Data

Inflation Factors

Finally, if multiple years are being compared, should inflation be taken into account? The proper application of an inflation factor is also described within this chapter.

Verification

Basically, can these data be verified? Is it reasonable? If an objective, qualified person re- viewed the data, would he or she arrive at the same conclusion and/or results? You may have to do a few tests to determine if the data can in fact be verified. If so, you should retain your back-up data, because it is the evidence that supports your conclusions about verification.

Monetary Unit Measurement

In regard to comparative data, we should ask: “Is all the information being prepared or under review measured by the same monetary unit?” In the United States, we would expect all the data to be expressed in dollars and not in some other currency such as euros (used in much of Europe) or pounds (used in Britain and the United Kingdom). Most of the manager’s data will automatically meet this requirement. However, currency conversions are an important part of reporting financial results for companies that have global opera- tions, and consistency in applying such conversions can be a significant factor in expressing financial results.

A MANAGER’S VIEW OF COMPARATIVE DATA

It is important for the manager to always be aware of whether the data he or she is receiving (or preparing) are appropriate for comparison. It is equally important for the manager to perform a comprehensive review, as described below.

The Manager’s Responsibility

Whether you as a manager must either review or prepare required data, your responsibility is to recall and apply the elements of consistency. Why? Because such data will typically be used for decision making. If such data are not comparable, then relying upon them can re- sult in poor decisions, with financial consequences in the future. The actual mechanics of making a comparative review are equally important. The deconstruction of a comparative budget review follows.

Comparative Budget Review

The manager needs to know how to effectively review comparative data. To do so, the man- ager needs to understand, for example, how a budget report format is constructed. In gen- eral, the usual operating expense budget that is under review will have a column for actual expenditures, a column for budgeted expenditures, and a column for the difference be-

tween the two. Usually, the actual expense column and the budget column will both have a vertical analysis of percentages (as discussed in the preceding chapter). Each different line item will have a horizontal analysis (also discussed in the preceding chapter) that measures the amount of the difference against the budget.

Table 14-1, entitled “Comparative Analysis of Budget versus Actual” illustrates the oper- ating expense budget configuration just described. Notice that the “Difference” column has both positive and negative numbers in it (the negative numbers being set off with parentheses). Thus, the positive numbers indicate budget overage, such as the dietary line, which had an actual expense of $405,000 against a budget figure of $400,000, resulting in a $5,000 difference. The next line is maintenance. This department did not exceed its budget, so the difference is in parentheses; the maintenance budget amounted to $290,000, and actual expenses were only $270,000, so the $20,000 difference is in paren- theses. In this case, parentheses are good (under budget) and no parentheses is bad (over budget).

USES OF COMPARATIVE DATA

Four common uses of comparisons that the manager will find helpful are discussed in this section.

Compare Current Expenses to Current Budget

Managers are most likely to be responsible for comparing the current expenses of their de- partment, division, unit, or program to their current budget. Of the four types of compar- isons discussed in this section, this is the one most commonly in use.

The preceding “Comparative Budget Review” used Table 14-1 to illustrate a comparison of actual expenses versus budgeted expenses. This format reflects both dollars and per- centages, as is most common. Table 14-1 shows the grand totals for each department

Uses of Comparative Data 153

Table 14–1 Comparative Analysis of Budget versus Actual

Hospital 1

Year 2 Actual Year 2 Budget Difference

$$ % $$ % $$ %

General Services expense Dietary $405,000 45 $400,000 46 $5,000 12.5 Maintenance 270,000 30 290,000 33 (20,000) (6.9) Laundry 45,000 5 50,000 6 (5,000) (10.0) Housekeeping 180,000 20 130,000 15 50,000 38.5 General Service expense $900,000 100 $870,000 100 $30,000 3.5

154 CHAPTER 14 Using Comparative Data

(Dietary, Maintenance, etc.) contained in General Services expense for this hospital. There is, of course, a detailed budget for each of these departments that adds up to the totals shown on Table 14-1. Thus, for example, all the detailed expenses of the Laundry depart- ment (labor, supplies, etc.) are contained in a supporting detailed budget whose total ac- tual expenses amount to $45,000 and whose total budgeted expenses amount to $50,000.

The department manager will be responsible for analyzing and managing the detailed budgets of his or her own department. A manager at a higher level in the organization— the chief financial officer (CFO), perhaps—will be responsible for making a comparative analysis of the overall operations of the organization. This comparative analysis at a higher level will condense each department’s details into a departmental grand total, as shown in Table 14-1, for convenience and clarity in review.

The CFO may also convert this comparative data into charts or graphs in order to “tell the story” in a more visual manner. For example, the total General Service expense in Table 14-1 can be readily converted into a graph. Thus Figure 14-1 “A Comparison of Hospital One’s Budgeted and Actual Expenses” illustrates such a graph.

Compare Current Actual Expenses to Prior Periods in Own Organization

Trend analysis, as explained in the preceding chapter, allows comparison of current actual expenses to expenses incurred in prior periods of the same organization. For example, Table 13-4 entitled “Trend Analysis for Expenses” showed total general services expenses of $800,000 for year 1 and $900,000 for year 2. The CFO could easily convert this information into a graph, as shown in Figure 14-2 “A Comparison of Hospital One’s Expenses Over

820000

840000

860000

880000

900000

920000

Year 2 Budgeted Expenses

870000

Year 2 Actual Expenses

900000

800000

Figure 14–1 A Comparison of Hospital One’s Budgeted and Actual Expenses.

Time.” (This information might be even more valuable for decision-making input if the CFO used five years instead of the two years that are shown here.)

Compare to Other Organizations

Common sizing, as explained in the preceding chapter, allows comparison of your organi- zation to other similar organizations. To illustrate, refer to Table 13-1, entitled “Common Sizing Liability Information.” Here we see the liabilities of three hospitals that are the same size expressed in both dollars and in percentages. Therefore, our CFO can convert the per- centages into an informative graph, as shown in Figure 14-3 “A Comparison of Three One- Hundred Bed Hospitals’ Long-Term Debt.”

Be warned that the basis for some comparisons will be neither useful nor valid. For ex- ample, see Figure 14-4, “A Comparison of Three Hospitals’ Expenses.” Here we have a graph of the grand totals from Table 13-2, entitled “Common Sizing Expense Information.” The percentages shown for the General Services departments of each hospital have been common sized to percentages, as is perfectly correct. However, Figure 14-4 attempts to com- pare the total General Services expense (the total of all four departments as shown) in dol- lars. As we can see here, hospital 1 and hospital 3 are both 100 beds, while hospital 2 is 400 beds. Obviously a 400-bed hospital will incur much more expense than a 100-bed hospital, so this graph cannot possibly show a valid comparison among the three organizations.

Instead, the CFO should find a standard measure that can be used as a valid basis for comparison. In this case, he or she can choose size (number of beds) for this purpose. The

Uses of Comparative Data 155

800000

600000

1000000

Year 1

$800,000

Year 2

$900,000

Figure 14–2 A Comparison of Hospital One’s Expenses Over Time.

156 CHAPTER 14 Using Comparative Data

resulting graph is shown in Figure 14-5, entitled “A Comparison of Three Hospitals’ Ex- penses per Bed.” As you can see, hospital 1’s cost per bed is $8,000, computed as follows. The total expense in Table 13-1 of $800,000 for hospital 1 is divided by 100 beds (its size) to arrive at the $8,000 expense per bed shown on the graph in Figure 14-5. Hospital 2

20%

40%

60%

80%

0%

100%

Hospital 1 (100 beds)

80%

Hospital 2 (100 beds)

75%

Hospital 3 (100 beds)

20%

Figure 14–3 A Comparison of Three One-Hundred Bed Hospitals’ Long-Term Debt.

$1,000,000

$500,000

$1,500,000

$2,000,000

$2,500,000

$3,000,000

$0

$3,500,000

Hospital 1 (100 beds)

$800,000

Hospital 2 (400 beds)

$3,000,000

Hospital 3 (100 beds)

$900,000

Figure 14–4 A Comparison of Three Hospitals’ Total Expenses.

($3,000,000 total expense divided by 400 beds to equal $7,500 per bed) and hospital 3 ($900,000 total expense divided by 100 beds to equal $9,000 per bed) have the same com- putations performed on their equivalent figures.

In actual fact, another step in this computation should be performed in order to make the comparisons completely valid. A per-bed computation implies inpatient expenses incurred, since beds are occupied by admitted inpatients. (Outpatients, on the other hand, use a dif- ferent mix of services.) Therefore, a more accurate comparison would adjust the overall total expense using one subtotal for inpatients and another subtotal for outpatients. Let us assume, for purposes of illustration, that the CFO of hospital 1 has determined that 70% of General Services expense can be attributed to inpatients and that the remaining 30% can be attrib- uted to outpatients. Let us further assume that hospital 1’s General Services expense of $800,000 as shown, is indeed a hospital-wide expense. The CFO would then multiply $800,000 by 70% to arrive at $420,000, representing the inpatient portion of General Services expense.

Compare to Industry Standards

In the example just given in the paragraph above, the CFO has computed his or her own hospital’s percentage of inpatient versus outpatient utilization of General Services expense. But this CFO may not have any way to know these equivalent percentages for hospitals 2 and 3. If this is the case, computing the per-bed expense using overall expense, as shown in Figure 14-5, may be the only way to show a three-hospital comparison.

The CFO, however, can use the 70% inpatient and 30% outpatient expense breakdown for another type of comparison. It should be possible to find industry standards that break

Uses of Comparative Data 157

$6,500

$7,000

$7,500

$8,000

$8,500

$9,000

$6,000

$9,500

Hospital 1 (100 beds)

$8,000

Hospital 2 (400 beds)

$7,500

Hospital 3 (100 beds)

$9,000

Figure 14–5 A Comparison of Three Hospitals’ Expenses per Bed.

158 CHAPTER 14 Using Comparative Data

out inpatient versus outpatient expense percentages. The use of industry standards is of particular use for decision making because it positions the particular organization within a large grouping of facilities that provide a similar set of services.

Healthcare organizations are particularly well suited to use industry standards because both the federal and state governments release a wealth of public information and statistics regarding the provision of health care. Figure 14-6, entitled “A Comparison of Hospital One’s GS Inpatient Expenses with Industry Standards,” illustrates the CFO’s graph using such a standard. (The figures shown are for illustration only and do not reflect an actual standard.)

MAKING DATA COMPARABLE

This section discusses annualizing partial-year expenses, along with using inflation factors, standardized measures, and currency measures. The manager needs to know how to make data comparable as a basis for properly preparing and/or reviewing budgets and reports.

Annualizing

Because comparability requires consistency, the manager needs to know how to annualize partial-year expenses. Table 14-2, entitled “Annualizing Operating Room Partial-Year Ex- penses,” sets out the actual 10-month expenses for the operating room. But these expenses are going to be compared against a 12-month budget. What to do? The actual 10-month ex- penses are converted, or annualized, to a 12-month basis, as shown in the second column of Table 14-2.

55%

60%

65%

70%

50%

75%

GS Inpatient Expense % Hospital 1

70%

GS Inpatient Expense % Industry Standard

60%

Figure 14–6 A Comparison of Hospital One’s GS Inpatient Expenses with Industry Standards.

These computations were performed on a computer spreadsheet; however, the calcula- tion is as follows. Using the first line as an ex- ample, $50,431 is 10-months worth of expenses; therefore, one month’s expense is one tenth of $50,431 or $5,043. To annualize for 12-months worth of expenses, the 10- month total of $50,431 is increased by two more months at $5,043 apiece (50,431 plus 5,043 for month eleven, plus another 5,043 for month twelve, equals 60,517, the annual- ized twelve-month figure for the year).

Inflation Factors

Inflation means “an increase in the vol- ume of money and credit relative to avail- able goods and services resulting in a con- tinuing rise in the general price level.”1 An inflation factor is used to compute the effect of inflation.

Table 13-4, entitled “Trend Analysis for Expenses” and presented in a prior chapter, compared hospital 1’s General Services ex- penses for Year 1 ($800,000) versus Year 2 ($900,000). We can assume that these amounts reflect actual dollars expended in each year. But let us also now assume that in- flation caused these expenses to rise by 5 percent in Year 2. If the Chief Financial Officer (CFO) decides to take such inflation into account, a government source will be available to provide the appropriate infla- tion rate. (The 5 percent in our example is for illustration only and does not reflect an actual rate.)

The inflation factor for this example is expressed as a factor of 1.05 (1.00 plus 5% [expressed as .05] equals 1.05). The CFO might apply the inflation factor to year 1 in order to give it a spending power basis equivalent to that of year 2. (Applying an in- flation factor for a two-year comparison is not usually the case, but let us assume the CFO has a good reason for doing so in this

Making Data Comparable 159

Table 14–2 Annualizing Operating Room Partial- Year Expenses

Expenses

Actual Annualized Account 10 Month 12 Month

Social Security 50,431 60,517 Pension 17,229 20,675 Health Insurance 7,018 8,422 Child Care 3,803 4,564 Patient Accounting 129,463 155,356 Admitting 91,878 110,254 Medical Records 76,432 91,718 Dietary 22,938 27,526 Medical Waste 1,981 2,377 Sterile Procedures 65,600 78,720 Laundry 33,911 40,693 Depreciation—

Equipment 72,815 87,378 Depreciation—

Building 34,481 41,377 Amortization—

Interest (4,849) (5,819) Insurance 3,513 4,216 Administration 48,305 57,966 Medical Staff 1,435 1,722 Community

Relations 41,511 49,813 Materials

Management 53,811 64,573 Human Resources 25,888 31,066 Nursing

Administration 68,726 82,471 Data Processing 14,846 17,815 Fiscal 14,750 17,700 Telephone 2,366 2,839 Utilities 22,005 26,406 Plant 64,664 77,597 Environmental

Services 27,395 32,874 Safety 1,680 2,016 Quality

Management 8,347 10,016 Medical Staff 7,870 9,444 Continuous Quality

Improvement 4,079 4,895 EE Health 474 569 Total Allocated 1,014,796 1,217,756 All Other Expenses 1,009,673 1,211,608 Total Expense 2,024,469 2,429,364

Source: Adapted from J.J. Baker, Activity-Based Costing and Activity-Based Management for Health Care, p. 190, © 1998, Aspen Publishers, Inc.

160 CHAPTER 14 Using Comparative Data

case.) The computation would thus be $800,000 year 1 expense times the 1.05 inflation fac- tor equals an inflation-adjusted year 1 expense figure of $840,000.

However, if the CFO wants to apply an inflation factor to a whole series of years, he or she must account for the cumulative effect over time. An example appears in Table l4-3, enti- tled “Applying a Cumulative Inflation Factor.” We assume a base of $500,000 and an annual inflation rate of 10 percent. The inflation factor for the first year is 10 percent, converted to 1.10, just as in the previous example, and $500,000 multiplied by 1.10 equals $550,000 in nominal dollars.

Beyond the first year, however, we must determine the cumulative inflation factor. For this purpose we turn to the Compound Interest Table. It shows “The Future Amount of $1.00,” and appears in Appendix 12-B. “The Future Amount of $1.00” table has years down the left side (vertical) and percentages across the top (horizontal). We find the 10 percent column and read down it for years one, two, three, and so on.

As shown in Table 14-3.2, the factor for year 2 is 1.210; for year 3 is 1.331, etc. We carry those factors to column C of Table 14-3.1. Now we multiply the $500,000 in column B times the factor for each year to arrive at the cumulative inflated amount in column D. Thus $500,000 times the year 2 factor of 1.210 equals $605,000 and so on.

Table 14–3 Applying a Cumulative Inflation Factor

Table 14–3.1

SOURCE OF FACTOR IN COLUMN C ABOVE: From the Compound Interest Look-Up Table “The Future Amount of $1.00” (Appendix 12-B)

Year Factors as shown at 10%

1 1.100 2 1.210 3 1.331 4 1.464

Table 14–3.2

(A) (B) (C) (D)

Real Cumulative Nominal Year Dollars Inflation Factor* Dollars**

1 $500,000 (1.10)1 � 1.100 $550,000 2 500,000 (1.10) 2 � 1.210 605,000 3 500,000 (1.10) 3 � 1.331 665,500 4 500,000 (1.10)4 � 1.464 732,050

*Assume an annual inflation rate of 10%. Thus 1.00 � 0.10 � the 1.10 factor in Column C. **Column D “Nominal Dollars” equals Column B times Column C.

Currency Measures

Monetary unit measurement, and the related currency measures and currency conversions are typically beyond most manager’s responsibilities. Nevertheless, it is important for the manager to understand that consistency in applying such measures and conversions will be a significant factor in expressing financial results of companies that have global operations.

Therefore, for comparative purposes we must determine if all the information being pre- pared or under review is measured by the same monetary unit. A few foreign currency ex- amples are illustrated in Exhibit 14-1. Currencies are typically converted for financial reporting purposes using the U.S.-dollar foreign exchange rates as of a certain date.

Exchange rates may be expressed in two ways: “in U.S. dollars” or “per U.S. dollars.” For example, assume the euro is trading at 1.3333 in U.S. dollars and at .7500 per U.S. dollars. That means if you were spending your U.S. dollar in, say, France (part of the “euro area”), it would take a third as much (1.33) in your dollars to buy products priced in euros. If your French friend, on the other hand, was spending euros for products priced in U.S. dollars, he or she could buy one quarter as much for his or her money (be- cause the U.S. dollar would be worth only three quarters [.7500] of the euro at that par- ticular exchange rate).

Standardized Measures

A final word about standardized measures. Standardized measures aid comparability. They especially assist in performance measurement. Types of standardized measures include the typical hospital per-bed measure along with work load measures.

There is, of course, a whole array of uses for standardized measures. Managed care plans, for example, may use a standard set of measures that are applied to every physician who contracts with the plan. Each physician then receives a report from the plan that illustrates his or her performance.

Finally, electronic medical records (as discussed in Chapters 19 and 20) depend upon standardized input. The input into various fields is standardized (and thus made compara- ble) by the very nature of the electronic system design.

Making Data Comparable 161

Exhibit 14–1 Foreign Currency Examples

Country (or Area) Currency

Canada Canadian dollar China Yuan Euro Area Euro Japan Yen Mexico Peso United Kingdom Pound

162 CHAPTER 14 Using Comparative Data

INFORMATION CHECKPOINT

What Is Needed? Example of a detailed comparative budget review (com- paring budget to actual).

Where Is It Found? With the supervisor responsible for the budget. How Is It Used? To find whether data are stated in comparable terms be-

tween actual amounts and budget amounts.

KEY TERMS

Annualize Inflation Factor Monetary Unit

DISCUSSION QUESTIONS

1. Do you believe your organization uses a flexible or static budget? Why do you think so?

2. If you reviewed a budget at your workplace, do you think the major increases and de- creases could be explained? If so, why? If not, why not?

3. Have you ever in the course of your work reviewed a report that had been annual- ized? If so, did you agree with how it appeared to be annualized?

4. Were you also able to see the assumptions used to annualize? If so, were you able to recalculate the results using the same assumptions?

5. Have you ever in the course of your work reviewed a financial report that applied in- flation factors? If so, were you able to see the assumptions used to apply the factors? If not, why not? Please describe.