Northeast Laboratory Conference

Key Financial Indices for a Laboratory Success Story

Portland, ME

October 17, 2018

Rodney W. Forsman

CLMA LCRC, FAAC Member

Assistant Professor Emeritus, Laboratory Medicine and Pathology, College of Medicine, Mayo Clinic

Financial Disclosures

Consultant Fees: Glenview, Gerson Lehman, AlphaSights, expert witness testimony

Board Membership/Stocks: Path-Tec

Expenses: NE Laboratory Conference

Federal Entitlement Programs: Medicare, Social Security

Learning Objectives

Recognize the basics of how to measure profitability

Express revenue recognition and the keys to a successful reimbursement program

Calculate the financial effects of volume on cost

Differentiate between fixed and variable costs

Formulate DRO and other key financial variables

10 Most Concerning Issues for Hospital CEOs

1. Financial challenges

2. Government mandates

3. Patient safety and quality

4. Personnel shortages

5. Patient satisfaction

6. Access to care

7. Physician-hospital relations

8. Population health management

9. Technology

10. Reorganization (e.g., M&A, restructuring, partnerships)

ACHE, Top issues facing hospitals 2017https://www.ache.org/pubs/research/ceoissues.cfm

Within financial challenges

1. Medicaid reimbursement

2. Increasing costs for staff, supplies, etc.

3. Reducing operating costs

Vertical Competitors

Taking Margin

Insurers Horizontal Competitors

Taking Patients

Other Medical Centers

Substitute Competitors

Activities/Margin

Imaging Centers

Surgi-Centers

Commercial Labs

Mobile MRIs

Cataract Institutes

Medical Centers Compete in Three Dimensions

Measuring Profitability

Income Statement or Profit and Loss statement (P&L)

Statement which measures results of an enterprise for a period of time

The income statement typically includes the enterprise’s revenues, expense and income or loss for the year

If net income you’re in the black

If loss, you’re in the red

Measuring Profitability

Revenue

- Expense

= Profit (contribution margin)

So why is it so difficult to get the numbers?

Hurdles to Understanding Profitability Outreach transactions get lost in the

hospital reporting systems

No specific identification of outreach program revenue

No specific identification of outreach costs

All costs are not captured

Cost are buried in other departments

Phlebotomy costs in a nursing cost center

Courier costs in materials management

Hurdles to Understanding Profitability Cost shifting and indirect expense

allocations

Lack of specific information regarding reimbursement

Revenues are commingled with in-patient charges

Specific bad debt rates are unknown

Identifying revenue and cost is key

Establish separate cost centers to capture direct costs (couriers, phlebotomy, supplies, etc.)

Agree on a pre-test analytical cost

Use a separate identifier (prefix, suffix, division code etc.) to capture outreach related revenues

Reimbursement and Revenue Recognition Defining Net Revenue:

Gross Charges (charge

schedule) $1,000,000

Less Contractual Allowances (A) 400,000

Less Discounts (B) 92,000

Equals Net Net Revenue $508,000

(A) Difference between gross charges and amounts legally

entitled to receive from an insurance plan (third party payer)

(B) Further amounts off for specific payer or clients (i.e.,

employer contract for services, or % off charge agreement)

Lack of Focus

Billing and Collections get lost in the hospital Billing and Collection systems

Claims of $20 - $50 may get little attention, large claims take precidence

Remote registration leads to inadequate data necessary to submit clean claims

Several Questions

How do I calculate my cost per test?

How can I accurately measure productivity?

How do I know what to charge?

Types Of Cost

Direct Test related Reagents Supplies Personnel time

Indirect Not directly attributable to a given test

Utilities Insurance Maintenance

Types Of Cost

Fixed Constant costs Overhead Depreciation

Variable Volume Dependant

Reagent Supplies

Types Of Cost

Direct

Indirect

Fixed Variable

Reagents

Labor

Equipment

Labor

Building

Institutional

Overhead

Electricity

Variable Cost Approximation

Variable Cost = ———————

Delta Volume

Delta Cost

Variable Cost Approximation

Previous volume = 1,000,000

Current volume = 2,000,000

Previous cost = $10,000,000

Current cost = $15,000,000

Variable Cost Approximation

Variable Cost = ———————

1,000,000 tests

$5,000,000

= $5.00 per test

Volume Effect on Unit Cost

Year 1 2

Variable Costs

($5.00/test)

$500,000 $600,000

Fixed Costs $200,000 $200,000

Volume

100,000 120,000

Unit Cost $7.00 $6.66

Increased volume can lower unit test cost by spreading fixed costs…assume 20,000 incremental volume

0

20

40

60

80

100

120

140

200 400 800 1200 1800 2200 3200

Volume

Co

st

per

test

Cost per test

Current Fee

Fixed costs

Average Cost Per Test Curve

Cost Allocation

The accuracy of the cost analysis program depends largely on the methods used for allocating expenses

Beware of

Outdated standards

Averages or “tweaking”

Manufacturer’s estimates

Overhead allocations based on volume

Costing Methods

Cost Allocation

Price based costing

Activity based costing

Management Tools Workload recording

Personnel utilization

Cost accounting

Cost effectiveness

Why Cost Accounting

Determine Break-even Point

Determine cost at capacity

Establish pricing

Measure contribution margin

Analyze laboratory expenses by procedure

Benchmarks

Personnel cost (% of Rev) 40-42%

Supply cost 15-19%

Rev/Employee/yr $60-70K

Rev/billable test $17-28

Tests/Mo/FTE (all staff) 450

Tests/Mo/FTE (technical) 765

Profit (% of Rev) 8-12%

Pro Forma Estimates

Revenue and cost:

$17 revenue/test

$12 total direct cost/test

$4.15 variable cost/test

$2.00 cost/test (logistics, sales, billing..)

Typical hospital with no outreach:

50% fixed cost

50% variable cost

What to Know to Price Lab Services

Variable and fixed costs of performing the test plus margin

Administrative outreach costs

Calculate your cost per test at capacity as well as based on current actual

Discounting - June 18, 2007

OIG withdraws proposed rule

Lacked information to establish a single numerical benchmark

Insufficient to ascertain if it would have the unintended effect of raising health care costs

Updating fee schedules is principal protection against overpaying

Discounting

Medicare Fee Schedule is not cost

Common practice within the industry

Not specifically prohibited by government regulations

Viewed by the government as discounted fees, not multiple fee schedules

Discounting

Recommendations

Establish pricing based on actual costs

May chill “loss leader” pricing by others

Share with those who ask for deep discounts

What is DSO/DRO?

Acronym for “Days Sales Outstanding” or “Days Revenue Outstanding”

Measures amount of time from month of sale to collection of cash

Calculation methods vary

Simple Method Example

Net A/R at June 30 $700,000

June Net Revenue $1,800,000

June YTD Revenue per

day ($1.8M / 181 days)

$10,000

DRO (AR/YTD Rev)

70 days

Exhaustion Method Example Days

Net A/R at June 30 $700,000

Exhaust:

June Net Revenue $300,000 30

Remainder $400,000

May Net Revenue $300,000 31

Remainder $100,000

April Net Revenue $300,000 10 *

71 DRO

*Since April remainder is less than the month’s net revenue

then divide the remainder ($100K) into the revenue and multiply

by the number of days in that month. ($100,000 ÷ $300,000) x 30

What Influences Your Bad Debt

Timely follow-up on claims not processed in 45-60 days

Timely follow-up on patient balance (once a month)

Strict monitoring on accounts 90 days or greater outstanding

Complete and accurate verification of insurance eligibility at time of testing

Balance Sheet

Balance Sheet aka Statement of Position

Statement which shows the financial condition of an enterprise at a point in time

The balance sheet typically includes values of an enterprise’s assets, liabilities, and equity or net worth

Balance Sheet

Assets equal Liabilities and Equity

Cash Flow

Cash Flow or Statement of Funds Flow

Statement which shows the change in cash over a period of time

NOI plus/minus changes in non-cash items (depreciation, change in AR, etc.) equals change in cash

Role Financial Ratios Play

Monitoring Key Financial Ratios can serve several important purposes :

Key Financial Ratios represent good (yet simple) measures of the current financial strength

Trends emerge highlighting important developments that may warrant corrective actions

Role Financial Ratios Play

Financial performance and credit ratio levels are also among a number of important factors assessed by external parties such as Moody’s and Standard & Poor’s in their bond rating of an organization

Measuring Performance

Performance of the lab

Performance of the management

The Role of Management

To optimize the return on resources entrusted to it

Money

Building, materials, equipment

People

Time

Measuring Success

Decease in controllable cost per unit of service

Volume filling excess capacity

Contribution to margin

Contribution in Net Operating Income

Measuring Success

Enrichment of the practice

Broader test menu creates efficiency in clinical practice

Market demands enhance service

46

Key to Success

Build Service

Sell Service

Deliver Service

Enhance Service

Financial Opportunities

Episode of care cost reduction through improved service by enhanced or retained test repertoire and turnaround time

Market opportunities exist for significant additional test volume from the community

Additional test volume spreads fixed cost, lowers unit cost

Revenue less cost for outreach testing provides additional contribution margin

Length of Stay

The number of fixed reimbursement patients is increasing (Medicare DRG and OPPS, PMPM plans, etc.)

Avoid an entire inpatient encounter

Reduce length of stay

Length of Stay

Average cost per inpatient day*

Non-profit ($1,332-$3,273)

For-profit ($787-$3,173)

*Relators Insurance Marketplace 2014

Recommendations

Budget for decreased reimbursements

Community labs need to continue to demonstrate the value of service and integration over price

Questions