What are the four common uses of comparative data

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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.