Chamberlain College of Nursing NR-630 Executive Practicum
Budgeting and Cost Management
Discuss with the nurse executive/mentor in your practicum setting how various costs are managed. Describe the extent to which cost-benefit analysis is used as a financial strategy to address the relative costs and benefits associated with a particular project or task. How are costs compared in terms of economic and financial impact?
Welcome to Week 6!
Nurses, physicians, other clinicians, administrators, and researchers are routinely confronted with the need to choose among different ways of performing their tasks or starting new services or programs. Awareness of the concepts and principles for evaluating the available options and the tradeoffs involved is the key to delivering maximized health outcomes and cost efficiency. In other words, concepts of cost-benefit analysis and their applications should be an integral part of the formal and informal decision-making processes of a nurse executive.
Course Outcomes
8
Delineate effective resource management and fiscal responsibilities of the nurse executive. (PO 8)
Weekly Objectives
• Examine factors that influence the decision-making process related to the fiscal responsibility of the nurse executive.
• Explain cost-benefit analysis of offering new services or continuing to offer current level of services within the organization.
Cost-Benefit Analysis and Break-Even Analysis
Cost-Benefit Analysis
Cost-benefit analysis is a particular type of economic evaluation that assists in healthcare decision making by assessing the relative merits of alternative courses of nursing/administrative action or interventions. The underlying belief of cost-benefit analysis is that resources are scarce and should be allocated in such a way as to maximize the improvement in care for the patient population (Finkler, et al., 2010). To achieve this goal, the following question is asked: Is this procedure, service, or program worth undertaking knowing that the resources involved will not be available for other things that are also beneficial? Nurses, physicians, other clinicians, nurse leaders, administrators, and researchers are routinely confronted with the need to choose among different ways of performing their tasks or starting new services or programs. Awareness of the concepts and principles for evaluating the available options and the tradeoffs involved is the key to delivering maximized health outcomes and cost efficiency. In other words, concepts of cost-benefit analysis and their applications should be an integral part of the formal and informal decision-making processes of a nurse executive (Finkler & McHugh, 2012).
Definition of Cost-Benefit Analysis (CBA)
Cost-benefit analysis was developed over 50 years ago. It was used extensively in the 1930s, during the Great Depression, for public decision making in connection with flood-control projects. Over time, cost-benefit analysis has been used with impressive results in a wide range of applications in such diverse fields as national defense, education, and healthcare (Finkler, Kovner, & Jones, 2010). Cost-benefit analysis is the measurement of the relative costs and benefits associated with a particular project or task. CBA summarizes both positive and negative impacts of a project. The purpose of CBA is to permit the nurse executive to select among alternative interventions by comparing them in economic terms. The economic evaluation compares the dollar costs of the inputs used in delivering the services with the dollar value placed on the outcomes resulting from the service. Inputs are the resources and other factors used in carrying out a procedure or project, such as equipment, administrative time, and providers’ time. Outputs are the end results or outcomes (Finkler, et al., 2010).
Why Do a CBA?
The nurse executive will be asked to do the following when executing a CBA.
• Assessment of the benefits associated with doing the task, providing the service, or developing a new program.
• Analysis of the costs associated with the task, service, or new program.
• Anticipated cost savings and the productivity benefits that will arise; in other words—is it worth doing the task once the costs and benefits are identified?
An example of a situation in which cost-benefit analysis is useful is when a nurse executive needs to choose between funding a new nurse-residency program or funding a training seminar for clinical nurse specialists. The two projects serve different purposes, but the hospital has funds to support only one project. A cost-benefit analysis of the two competing projects can provide the nurse executive with helpful information for this decision. The goal of any cost-benefit analysis is for the nurse executive to predict the impacts and consequences of a business transaction to determine a return on investment, or financial justification of a project, and a cost of ownership analysis. Money and time are the common units of measurement (Finkler & McHugh, 2012).
Cost-Benefit Formula
The basis of the cost-benefit analysis is simple: to determine whether the benefits of a particular project outweigh the costs. The following formula is used:
NB = B – C
In this formula, NB represents the expected net benefits of a project, B is the expected total benefits from that project, and C is the expected total costs (Finkler, Kovner, & Jones, 2010).
For example, suppose three public health programs—a breast cancer screening program for adult women, a nutrition program for school-aged children, and an anti-smoking program for adolescents—are presented for funding. Suppose, too, that all three programs have been shown to be effective in achieving their intended objectives. A cost-benefit analysis can be applied to estimate the total benefit and costs of the three competing programs to determine the net benefits of each. An estimation of net benefits in terms of a common unit, dollars, makes it possible to discern whether a particular program generates greater net benefits for society than competing projects.
Now, let’s suppose that a nurse executive is deciding whether to implement a shared-governance program to enhance staff-nurse engagement and nursing autonomy and independence. The shared-governance program’s underlying philosophy will be to support clinical practice using the principle of participatory management. The nurse executive can utilize a cost-benefit analysis to identify and measure both the direct and indirect costs of the program and direct benefits to the organization and the nursing staff.
In carrying out a cost-benefit analysis, the nurse executive can ask a series of three practical questions.
1. Which costs should be included in the cost-benefit calculation?
2. Which benefits should be included?
3. How should future costs and benefits be treated?
The costs that should be included in the analysis would consist of: meeting time for nurses to attend unit-based and organization-wide shared-governance meetings, time for nurses to complete projects, staff coverage, materials for completing special projects, and for nurses to attend other hospital-wide meetings. The benefits included in this analysis would be staff- satisfaction scores, retention rate of nurses, patient-satisfaction scores, and project outcomes. If the benefits outweigh the costs, then implementing shared governance is an optimal decision for the nurse executive (Finkler, et al., 2010).
Types of Cost Analysis
In the healthcare literature, several different types of cost analysis are used.
• Cost-benefit analysis—The outcome or benefits of a program are measured in terms of dollars.
• Cost effectiveness—The benefits are measured in terms of health units.
When costs and outcomes are measured in terms of dollars, cost-benefit analysis is the appropriate tool to use. The costs are subtracted from the benefits to determine the net economic benefit. This analysis permits the comparison of alternatives, since all costs and benefits are converted into dollars.
Cost effectiveness is used to evaluate competing programs that are designed to achieve the same or similar objectives. Because the program outputs are assumed to be the same, attention is focused on the identification and estimation of program costs, thus avoiding many of the difficulties of benefits estimation. For example, both physicians and nurse midwives can provide routine prenatal care, but the costs and effectiveness may be very different. Cost-effectiveness analysis can be used to evaluate the relative merits of the two types of healthcare providers who can serve the needs of the same group of patients.
Breakeven Analysis
Break-even analysis is used to determine at what point a new program or service will break-even and then start to make money (Finkler, et al., 2010). The analysis is based on the following formula.
The breakeven quantity (Q) =
Fixed Costs (FC)
Price (P) – Variable Cost per Patient (VC)
Or
Q = FC
P – VC
Where Q is the number of patients needed just breakeven.
FC is the total fixed cost.
P is the assumed average amount collected per patient.
VC is the variable cost per patient.
At a quantity lower that Q, there would be a loss; at a quantity higher than Q, there would be a profit. P is assumed to be the average amount of revenue the organization ultimately receives per patient. The basis for the formula is the underlying relationship between revenues and expenses. If total revenues are greater than expenses, there is a profit. If total revenues are less than expenses, there is a loss. If revenues are just equal to expenses, there is neither a profit nor a loss, and the service is said to just break-even (Finkler, et al., 2010).
Example:
Suppose a healthcare organization opens a new home-health agency that charges, on average, $50 per patient visit. The agency has fixed costs of $10,000—salaries, equipment, supplies, and other miscellaneous and overhead. Also, the agency has variable costs of $30 per patient—home instructions based on patient diagnosis, additional office supplies, traveling expenditures per nurse, etc. If there are no patients at all, there is no revenue, but there are fixed costs of $10,000, and there is a $10,000 loss.
Each patient brings in $50 of revenue, but causes the agency to spend $30 more per patient. The difference between the $50 price and the $30 variable cost is $20, and called the contribution margin. The contribution margin from each patient can be used to cover fixed costs.
Let’s say that the agency sees 100 patients. There is a contributing margin of $20 for each of the 100 patients, or a total contribution margin of $2,000. The agency would still be operating at a loss of $8,000. How many patients would the agency need to have to break even? Using the break-even analysis formula:
Q = FC = $10,000 = $10,000 = 500 Patient Visits
P – VC $50 – $30 $20
Five hundred patients would generate $10,000 of contribution margin; exactly enough to cover fixed costs. If the agency sees 500 patients, it will just break even.
Additional Example:
When there are different types of patients, the break-even analysis becomes more complicated. If there are different types of patients with different prices, it is necessary to find the weighted average contribution margin.
Suppose for this new home-health agency, there are three different classes of home visits. The price for the visits is $100, $75, and $50. The variable costs for the visit are $30. The contribution margin for each type of patient can be calculated by subtracting the variable cost from the price as follows.
Price Variable Cost Contributing Margin
Complex $100 – $30 = $70
Moderate $75 – $30 = $45
Simple $50 – $30 = $20
The crucial piece of information for calculating the break even point is the relative proportion of each type of visit. Let’s say that 20% of all visits are complex, 50% are moderate, and 30% are simple. This information can be used to calculate the weighted average contribution margin. This requires multiplying each type of contributing margin by the percentage of patients that make up that type of visit, and then adding the sum of those results to attain the total weighted average contributing margin.
Percentage of Visits Contribution Margin Weighted Average Contribution Margin
Complex 20% x $70 = $14.00
Moderate 50% x $45 = $22.50
Simple 30% x $20 = $6.00
Total Weighted Average Contribution Margin: $42.50
The $42.50 weighted represents the average contribution margin for all types of visits. It can be used to calculate the break-even quantity. Assume that fixed costs are at $10,000.
$10,000 Q = $42.50 = 235 visits
Of the total 235 visits, 47 would be expected to be complex (20%), 118 moderate (50%), and 70 visits as simple (30%). The same weighted average approach could be used to find the break-even volume when there are more than three different types of patients.
Suppose we want to know the exact day when a profit for the new home-healthcare agency will begin. Using the same home-healthcare-agency example, days to break even is calculated as follows.
Days to break even = # of patients to break even
# of patients the agency serves per day
Let’s say that the agency sees 1800 patients during its first year of operation, 20% of which are complex, 50% patients are moderate care, and 30% are simple. The days to break even is calculated as follows.
Price Variable Cost Contributing Margin
Complex $100 – $30 = $70
Moderate $75 – $30 = $45
Simple $50 – $30 = $20
# of Percentage Contribution Weighted Average
Patients of Visits Margin Contribution Margin
Complex 360 20% x $70 = $14.00
Moderate 900 50% x $45 = $22.50
Simple 540 30% x $20 = $6.00
1800 $42.50
$10,000
Q = $42.50 = 235 visits
# of patients served per day = # of patients seen per year
# of days per year
= 1800 = 4.93 patient per day
365
Days to break even = # of patients to break even
# of patients the agency serves per day
= 235 = 47.6
4.93
The new home-healthcare agency will break even on the 48th day of operation and, on the 49th day of operation, will start to make a profit.
References
Finkler, S., Kovner, C., & Jones, C. (2010). Financial management for nurse managers and executives (3rd ed.). Philadelphia, PA: Saunders Publishing.
Finkler, S., & McHugh, M. (2012). Budgeting concepts for nurse managers (4th ed.). Philadelphia, PA: Saunders Publishing.
================