Summary Financial Management of
Healthcare
HPI4007
Case 1 – Cost-price calculation and tariffs ...........................................................................................2
Case 2 – Planning and Budgeting.........................................................................................................7
Case 3 – Renovating or contracting out? ........................................................................................... 12
Case 4 – Shall I do an economic evaluation? ...................................................................................... 15
Additional lectures ............................................................................................................................ 18
1
,Case 1 – Cost-price calculation and tariffs
Financial management
Financial management is about managing money and the process of financial decision making within
an organization to meet the organization’s (financial) goals efficiently and effectively. It’s needed due
to scarcity and it’s long term. Elements of financial management (going in a circle):
- Planning: of enough funding at the right time (do the year beforehand) – production, payments
- Control: is the organization meeting its objectives (during the running year) – resources,
performance
- Decisions: where and how much to invest – mix, funding, returns
Healthcare organizations need financial management because of the complexity of HC (quality,
accessibility, ethics concerning the population and cost recovery and profitability concerning the
business). Additional challenges are: the rising HC costs and the business orientation vs. ethical
standards (e.g. openness, transparency).
Costs
Costs are determined by the inputs / resources used and the value of resources used → Costs = the
monetary value of inputs (resources) that are necessary for the production of one unit.
Costs are important for planning (e.g. to estimate the unit cost-price), evaluation and control, and
decision-making (e.g. to set market prices or to decide on investments). Cost information is thus used
for resource allocation and pricing. Moreover resource allocation; examples of HC decisions in which
financial management plays a role: closing a ward, running an outpatient clinic etc.
There are two perspectives on costs:
- (Health) Economic perspective - Opportunity costs = value of alternative benefits sacrificed
- (Financial) management/managerial perspective – Accounting costs = monetary value of
production inputs. Types of costs below.
Types of costs
Cost behaviour:
- Fixed costs (business expenses that do not change if the production level changes) VS. Variable
costs (business expenses that do change if the production level changes)
o Semi-variable (/semi-fixed/mixed) costs = contains both a fixed and a variable element
- costs are fixed for a set level of production or consumption, and become variable
after this production level is exceeded (e.g. telephone or electricity)
o Stepped costs = expenses that are constant for a given level of activity, but increase
or decrease once a threshold is crossed (e.g. employing a new employee)
- Direct costs (a price that can be completely attributed to the production of a specific good or
service) VS. Indirect costs (costs that cannot directly be attributed to the good or service)
o Fixed, Variable, Direct and Indirect costs can be coupled → costs as a multi-attributed
concept, examples:
Direct Costs Indirect Costs
Variable Costs Costs of material (direct input for Costs of electricity (no directly input for
the unit and changes with quantity) the unit but changes with use)
Fixed Costs Costs of labor (direct input for the Costs of land (no direct input and
unit but is fixed per month) doesn’t change)
- Additional (basic) types of cost behaviour:
o Progressive: relatively higher costs for a higher quantity
o Proportional: Mixed / Variable / Fixed costs
o Degressive (relatively lower for a higher quantity)
2
,Financial managers talk about financial costs - the monetary value of production inputs. Regarding this,
different types of costs and measuring costs can be identified (which one to use is dependent on the
purpose):
- Historical costs = the original purchase price of an asset recorder on a company’s balance sheet
(e.g. includes not only the price of a machine but also shipping and installation costs) (often
does not reflect current fair market value)
- Replacement costs = the cost you’d have to pay to replace an asset with a similar asset at the
present time and value
- Operational costs = expenses associated with the maintenance and administration of a
business on a day-to-day basis (e.g. accounting and legal fees, sales and marketing, interest
pay, rent, salary and wages etc.)
- Purchase costs = the costs of having an external organization produce a service on your behalf
- Costs of capital = cost of funds used to finance a business, e.g. in the form of shares, borrowing
from banks or bonds. The total = cost of equity + cost of debt → the cost of capital
- Overhead costs = includes all ongoing business expenses not including or related to direct
labour or direct materials used in creating a product or service. Thus, costs that support the
making or selling of a product or service; must be paid on an ongoing basis. E.g. rent, heating,
central management etc. Generally fixed, sometimes variable. Needed in budget planning →
to determine the break-even point
- Total costs (/full costs = total of fixed, variable, semi-variable and stepped costs for a particular
level of activity + indirect costs) VS. Partial costs (all costs excluding indirect/overhead costs)
o Total costs can be used for a Flexible budget – this is a budget that shows comparative
costs for a range of activity levels. This can help to determine the ideal scenario.
- Marginal costs (the change in production cost resulting from production of one more unit →
dTotal Costs / dQuantity) VS. Average costs (costs per unit calculated by dividing the total costs
by the number of units produced)
Apportioning indirect / overhead / shared costs
Cost allocation = concerns direct costs, charges the entire cost to the cost centre directly responsible
Cost apportionment = concerns indirect costs, shares costs between cost centres in proportion to the
level of use. This can be done in two ways:
- Activity-based – (ABC = activity-based costing) allocate costs to reflect the activity level (the
preferred approach)
o E.g. number of requested X-rays, number of operations
o Two types:
▪ Job order costing = average unit cost for each job delivered
▪ Process costing = average unit cost for each service in a given time period
o Process-based method – activity-based e.g. regarding departments (production-
centre method) or regarding process steps
o Output-based method – based on the product / service produced, dividing the indirect
costs over all units produced (thus only for homogenous output)
- Non-activity based
o E.g square metres, staff
o Input-based method – based on the resources needed for the production process
(non-activity based), thus the indirect costs are distributed among outputs taking into
account the needed inputs
▪ Surcharge method (percentage) – the indirect costs per unit material
3
, Break-even analysis
Break - even when the Net Financial Result is 0 → The Total
Revenue equals the Total Costs
- [Net Financial Result] = [Total Revenue] – [Total Costs]
o [Total Revenue] = [Price] * [Quantity]
o [Total Costs] = [Variable Costs of unit (Vcu)] *
[Quantity] + [Total Fixed Costs]
- Under uncertainty: the quantity of demand is not constant → calculation using the mean and
the standard deviation, leading to a probability of making loss and probability of making profit.
Cost recording
Specifying on what the money has been spent (line items), where it was spent (functional costs), and
in which specialty (specialty costs) → cost coding system. Needed to support decision making
(management accounting) and to enable financial statements for e.g. regulatory bodies (financial
accounting). Related:
- Cost accounting – determining the full or incremental costs of providing a service to patients
- Cost centre – any activity or unit of organization for which you want to identify the costs
Prices and pricing
Prices = the amount of money that a healthcare provider receives for a product or service delivered.
Prices are determined by unit-costs, demand, willingness to pay, characteristics of the product and the
short and long-term objectives of the provider (→ cost + profit). In HC, the information asymmetry,
complicated demand, third-party payment, and limited consumer sovereignty affect pricing and
classical economic theories do not explain everything → imperfect competition (firms are in control of
prices as barriers to access).
Marketing Mix
In HC: if a service is provided in the right way (right quality and quantity) pricing decisions depend on
the marketing mix = the four P’s:
- Price
- Product: important in HC are quality, diversity and timeliness of the product / service, the
competitive environment pricing depends on market share and market growth
- Place: e.g. accessibility is important
- Promotion: generate awareness, confidence, acceptance and identification (external but also
internal)
Approaches to pricing
Different costing methods / approaches regarding what costs to include for pricing:
What Advantages Disadvantages
Bottom-up approach - Helps clinicians to manage - Expensive
A detailed approach identifying the costs financial performance - Time-consuming
of all inputs - Costs change with changes in
clinical practice
Top-down approach - Quick and easy - No linkage to variation in
Based on average costs - Suitable for low-volume, low- clinical practice as it is based
cost procedures on average costs
4
