Maastricht University – Master Healthcare Policy, Innovation and Management 2016-2017
HPI4007 Financial management of healthcare organizations
Summary
Case 1 Cost-price calculation and tariffs
Costs and prices
Types of costs
Costing and pricing process
Costing
Cost behaviour
Allocating costs
Pricing
Diagnosis related groups
Case 2 Planning and budgeting
Budget
Budgeting and forms of budget
Budgeting process
Responsibility and control
Variance analysis
Shift away from traditional budgeting
Case 3 Renovating or contracting out
Capital investment
Investment analysis
Strategies of capital investment
Time value analysis
Selecting an investment option
Other concepts related to investment decisions
Case 4 Shall I do an economic evaluation
Health technology assessment in hospitals
Hospital-based HTA
Mini-HTA
Budget-impact analysis
Other available economic evaluation techniques
Additional lectures
Lecture on business case
Lecture on investing in computerization
Lecture on double-entry registry and cash flow statement / financial statement analysis
, Case 1 Cost-price calculations and tariffs
Learning goals:
1. What is the difference between price and costs?
2. What are the different types of costs and how do you use them? (different types of costs)
3. What methods of cost price calculation are there and what is their purpose? (what to do with those costs)
4. What is a DBC/DOT and how can you price them? (how to determine a price)
Costs and prices
Defining costs (lecture) (!):
- Definition according to the (health) economic perspective: Costs are seen as opportunity
costs, so the value of the alternative benefits sacrificed.
o Opportunity costs (economic concept): Cost of what you could have done or gotten
instead. Most fundamental cost concept from the economic perspective.
§ Full cost (of an illness, intervention, etc.) borne by society, based on oppor-
tunity cost (income or benefit forgone as a result of carrying out a particular
decision), regardless whether resources were purchased or not (Gruen).
§ [Cost of what else you could have bought] + [What you did not earn instead]
§ Resources have value only because they are used for good that has value.
§ Hard to use and quantify, but very important within the healthcare sector.
§ Example: Saving medical institutional costs by discharging patients earlier.
- Definition according to the (financial) management/managerial perspective: Costs are seen
as accounting costs, so the sum of the costs of all resources consumed to produce it.
o Financial (budgetary) costs (Gruen): Measure the monetary value of the resources
(the inputs required for a production process).
o Important cost-accounting concepts: Total, fixed, variable, marginal, average costs.
§ Marginal costs: See ‘Costing’.
o Accounting perspective has a very clear view on what costs are and what profit is.
Defining prices (Gruen): According to economic theory: The price regulates the quantity of a good or
service demanded and supplied.
- A price cannot be set if you don’t know the costs.
- Prices can reflect society’s opportunity cost.
Differences between costs and prices (!):
Costs Prices (/market price/tariff)
The monetary value of inputs (resources) that The amount of money that the healthcare provider
are necessary for the production of one unit. receives for a product or service delivered.
Determined by inputs (Mogyorosy). Determined by demand (Mogyorosy).
What it costs you to make a product or provide The money you ask for a product, usually plus or minus
a service (so not equal to expenses/outflow!). the profit (so not equal to only the market price!).
Usually reflected in the price, but does not have Does not necessarily reflect full costs: For internal markets
to. in most health systems, total prices must equal total costs.
- Set by the insurer/government (overview lecture).
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,Types of costs
Types of costs (Gruen, lecture) (!): Try to estimate the
cost price based on the production inputs, by looking
at (see below for each type of costs):
- Historical vs. replacement costs.
- Operational costs vs. costs of capital.
- Total vs. partial costs.
- How does cost relate to production? What is the unit of analysis? à Direct vs. indirect costs.
- Does it vary with quantity? What is the timeframe? Fixed vs. variable costs.
Historical vs. replacement costs:
- Historical costs: The amount of money paid for the resources used. The original costs of an
asset.
- Replacement costs: What it would cost in today’s money to replace the resources that have
been used. Current costs.
Operational costs vs. costs of capital:
- Operational expenses/costs: Costs incurred by an organization in the course of its ordinary
activities.
- Capital: The funds invested in the organization by its owner(s).
- Amortized (aflossen) capital cost: Fixed cost flow associated with the initial capital outlay.
Total vs. partial costs:
- Total costs: Total cost per unit of time of producing Q units of output per unit of time.
o Includes a time dimension: Costs are flows, not stocks.
- Partial costs: All costs controlled by production unit, excluding overhead costs.
o Most used for cost control short term decisions.
Direct vs. indirect costs (based on the assessment of financial costs of a service) (!):
- Direct costs: Costs of resources used directly by the service (in the design, implementation,
receipt and continuation of a healthcare intervention).
o Example: Doctors, nurses, drugs, equipment such as bandages.
- Indirect costs: The value of resources provided by support units (expended by patients and
their carers to enable individuals to receive an intervention).
o Still indirectly related to the products you make. Not directly attributable to a cost
object. E.g. you make tables, you need to transport the wood to the factory by train.
The train costs money, but you need the train to produce.
o Example: Radiology, catering, supplied centrally to many users, laboratory tests.
- Overhead costs: Costs that are not incurred directly from providing patient care but are
necessary to support the organization overall.
o Purely supporting. Not immediately related to production. E.g. the HR department,
management, security. Not need to produce (the primary production process).
o Example: Personnel functions, central management, security, accounting, lighting.
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, Fixed vs. variable costs (!): A division according to the behaviour of costs.
- Fixed costs: Costs which stay constant with changes in volume/activity over a period of time.
o The costs of resources which must be paid for before any activity occurs, but which
stay fixed as activity increases. So, the cost of production that does not vary with the
level of output. But on the long run (e.g. >1 year), fixed costs can also change.
o In a graph, this is represented with a constant function, a horizontal line (b).
o The shorter the period of time, the greater the number of costs are likely to be fixed.
o Example: Staff salaries (of permanent staff), buildings’ maintenance, depreciation.
- Variable costs: Costs which change simultaneously (gelijktijdig) with activity/patient volume.
o When activity increases, costs go up; when activity decreases, costs go down. So, the
cost of production varies directly with the level of output.
o In a graph, this is represented with a linear equation with a slope (a).
o Example: Drugs, appliances.
- Semi-variable costs: Costs which contain both a fixed and a variable element.
o Arises where resources incur a standing charge that is payable regardless of whether
the input is used, plus a variable cost when activity increases.
o In a graph, this is represented with a linear equation with slope and intercept (c).
o Example: Telephone-bills, electricity.
- Stepped costs: Costs which behave like fixed costs, only until a certain threshold is reached.
o When activity increases further, costs step to a higher level and remain fixed until
the next threshold level of activity is reached.
o Usually related to capacity constraints.
o In a graph, this is represented with a gradual line (d).
o Example: Rentals, equipment and machinery, when it is e.g. necessary to employ
another member of staff.
(a) Variable (b) Fixed (c) Semi-variable (d) Stepped
Costing and pricing process
Stages in the costing and pricing process (Gruen):
1. Define clearly the service for which you want to calculate prices: Define the unit of activity
or ‘currency’ you want to use to set prices.
2. Identify the costs of providing these services: Using a top-down or a bottom-up approach.
3. Decide on the level of costs you aim to recover by pricing: By average or marginal costs.
4. Take account of the planned activity level.
5. Account for any associated costs: Depends on whether these costs should be included in the
price of the service or be reimbursed separately.
6. Adjust for inflation: Instead of using an average rate, use different rates for e.g. staff, drugs.
7. Work out the price per unit of activity.
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