Tout your successes to financial adminis- trators in the language that gets results.
It is no secret that health care costs have been rising faster than the country’s inflation rate for a number of years now. While there are many factors that contribute to this, one in particular is a recurrent area of complaint: the high cost of original equipment manufacturer (OEM) repair parts. About once per week, a subscriber posts a message on an Internet-based biomed discussion forum (email@example.com) bemoaning the high cost of repair parts for medical equipment.
Admittedly, parts bought from the OEM can be quite expensive, and there are many justifiable business reasons for an OEM’s parts-pricing structure. But when biomeds find the identical repair part at a substantially lower price, it is their right—and many feel it is their duty—to share this information so that other biomeds can benefit from their discovery.
Seeking out the correct repair part at a price that is substantially lower than the OEM’s price seems to be inherent in the nature of a biomed. We abhor paying $25 for a part worth only $5 and will quickly purchase the bargain-priced part once it is proven to be equal to the one the OEM will gladly sell us for five times that amount. When the biomed buys the $5 part, he or she basks in the warm fuzzy feeling that he or she saved the organization $20 in excessive costs.
Saving the organization’s money is good; communicating those successes to our bosses and upper-echelon decision-makers is better; communicating it in terms they readily understand is best. This is not an innate skill of a typical biomed. Biomeds think in electronics terms, while financial-types think in … well … financial terms. To impress the financial-types with our true value, biomeds need to learn two things: the basics of finance to understand the true value of the money we save, and how to wow the suits in the business office with our contributions to the bottom line.
The Business of Health Care 101
Every working person intuitively knows that an organization must make more money than it spends; otherwise, it goes bankrupt and out of business. The same is true in the health care business—and, yes, health care is a business. Even not-for-profit hospitals must operate as businesses to remain solvent year after year. Remember, the phrase “not-for-profit” means to both perform a community service and to break even at the end of the fiscal year, not to lose money. However, not everyone realizes how this money flow works, or how much more income than outgoing money is required to sustain a health care facility.
The amount of revenue required to generate the necessary income depends on something called “margin,” or the ratio of gross revenue to net income. Net income is the amount that remains after the operating costs are subtracted. A glance at your own pay stub or voucher will illustrate the difference between gross income and net income. Gross income is the hourly salary times the number of hours worked. Net income is the amount that remains after taxes, social security, Medicare, and retirement-plan contributions, etc have been deducted from the gross income.
In the United States, the unofficial “Tax Free Day” is sometime in late May. By “Tax Free Day,” we have earned about 46% of our total income for the year, and it all went toward these deductions. The 53% we earn from then until the end of the year is ours to keep. Thus, out of every dollar we earn, we only get to keep 53 cents.
So, the next time you look at that $80 fishing reel or car accessory and think, “I make $20 per hour; that’s only half a day’s work,” you would be very much mistaken. To clear that $80, you must earn $150 by working more than 71¼2 hours—almost a full day. The math works like this: Working 71¼2 hours at $20 per hour earns $150. Next, multiply $150 by 53%, because you keep only 53 cents out of every dollar earned. This equals $79.50, or about $80.
While a hospital does not have the same deductions a worker does, there are quite a number of deductions that affect the net income, or bottom line. Look at the sample income statement from a fictitious for-profit health care institution we will call Doctor’s Hospital. Note the small amount of money that remains after expenses are deducted from the gross revenue. Bear in mind that the gross revenue is not the amount that the hospital bills the insurance companies, but it is the amount of cash actually paid by insurers and patients through the facility’s billing office. Also, notice that from the more than $3 million in gross revenue, less than $100,000 remains as net income. Taking the ratio of the two and expressing profit as a percentage (or margin), we would have:
In other words, taking the net income of $97,600 from the fictitious Doctor’s Hospital, and dividing it by the hospital’s gross revenue of $3,234,400, then multiplying it by 100, we arrive at 0.030, which is multiplied again by 100 to arrive at 3%. Hence, we say that Doctor’s Hospital operates at a 3% profit margin, or simply a 3% margin.
Looking at things from the bottom line, what do you suppose the gross revenue would be in order to make a single dollar? By substituting numbers from the Doctor’s Hospital income statement shown into a variation of the same formula, we arrive at the solution of:
In other words, it takes approximately $33.33 of gross revenue to yield a single dollar of net income. Remember, the $33.33 just covers the facility’s expenses—it has made only a single dollar of “profit” in its true sense.
What is to become of this $97,600 of net income? Some of it eventually goes into the pockets of the doctors and other shareholders. The bulk of the net income at hospitals is spent purchasing new equipment (depreciation covers only equipment replacement and is limited to purchase price less scrap value), expanding existing services, initiating profitable new ventures, and acquiring the new technologies necessary to advance the health care activity.
Using our fictitious hospital, part of the rising cost of health care may also be driven by increasing the automation in the laboratory through the purchase of a new batch analyzer to replace manual chemistries, or by adding a mammography unit to a women’s health center.
Opening a new day-care center in the hospital would require “new” money. If a facility does not have the cash to make the purchase, then money is borrowed and interest is paid on the loan. All this adds to the increasing cost of health care. Why this short course in hospital finance? To educate, of course, so that the second part of this article will be fully appreciated.
An Old Adage Applied To Modern Times
Ben Franklin once said, “A penny saved is a penny earned.” However, you need to understand the context of that statement. That was advice to the individual, and that was before income taxes and before all of the other deductions now taken from our pay. In the business world, this statement is no longer true. A penny saved is much more than a penny earned. In fact, the saved penny goes directly to the bottom line, while the penny earned is probably worth only about 1/20th of a cent after expenses. Confused by that last statement? That’s the problem. We biomeds received excellent training in electronics and on general medical equipment, but very little business training. As a result, administrators and biomeds view life through very different glasses.
To the hospital’s financial administrator, there are basically two entities in the organization: profit centers and cost centers. The biomed department is usually a cost center. That is, the perception is that in-house biomeds cost the organization money rather than save money or generate revenue. Radiology, the laboratory, and the pharmacy, for example, are profit centers, since they generate revenue for the facility through billings and insurance reimbursements.
Conventional financial wisdom dictates that the way to improve the bottom line—in other words, to increase net income—is to reduce the expense of cost centers and increase the contribution of profit centers. Simply put, outsourcing or reducing the funding of cost centers will improve the bottom line by reducing the operating expenses. That is why many OEMs outsource their customer service to third-world countries: to reduce operating expenses.
However, this concept is somewhat shortsighted when viewing a biomed department. If one looks deeply into a conventional health care profit center, one finds that its maintenance expenses offset, or reduce, its profits. However, as long as its profits are substantially greater than its expenses, all is well as far as the CFO is concerned.
Speaking a New Language
In the previous example, the impact of saving a dollar is identical to generating more than $32 in gross revenue. In both cases, the institution is a dollar ahead at the bottom line, but saving a dollar means neither paying out any expenses, possibly including taxes, nor having to “work” to acquire it. Saving a dollar is not easy, and generating new revenue is tough; but in the modern business world, reducing costs is preferable to generating new revenue. Telling accounting administrators that a biomed department saved $285 just does not have the punch and pizzazz that saying the department generated the equivalent of $7,600 with no additional expenses or overhead does. However, this is only one example of the unsung value that in-house biomeds regularly provide to the organization.
Suppose a single biomed shop saves money on parts several times per month, saving the equivalent of $10,000 or $20,000 of additional revenue each month. Over the course of a year, this adds up to a considerable revenue equivalent. This is a point that biomeds need to understand and clinical engineers and biomed managers need to champion to the financial administrator, comptroller, and CFO.
The true value lies not in the income the biomed maintenance operation generates, but in the equivalent gross revenue generated every time the biomed department saves money. When a biomed finds the same part for $150 less or does a service for $150 less than the OEM or a third-party maintenance firm, that $150 is the equivalent of having an unexpected $5,000 payment showing up in the morning mail. That needs to be relayed to management as, “If we were a profit center, we would have generated $5,000 in additional revenue,” instead of, “We saved $150.”
Biomeds need to track these savings over months and years and bring this to the administrators’ attention in the language that financial-types understand. That language should illustrate how a biomed department’s savings directly contribute to the facility’s bottom line. Once financial administrators understand this point, they begin to understand that the way to reduce expenses is not to reduce a biomed department’s budget, but to increase the department’s budget and capabilities.
Health care facility administrators need to give biomed departments the money to hire and train new staff, obtain additional work space, acquire new test equipment and service aids, and develop a parts budget to enable the department to take on new maintenance missions often hidden within other departments because they are contracted out. This is but one way health care facilities can help stem the rising cost of health care. 24×7
Robert M. Dondelinger, CBET-E, MS, is chief, Logistics Services Branch, Acquisition Division, Resource Management Directorate, US Military Entrance Processing Command, North Chicago, Ill.