Cost Variance and Budgeting: Reflecting on Health Care Finance

In most understandable terms, variance simply refers to the difference occurring between a planned or budgeted amount, with respect to its actual cost. This means that, if an organization plans to incur expenses amounting to say $500 but ends up incurring expenses of $600, there is variance of $100. In light of this, when the actual costs exceed the budgeted cost, the resulting variance is termed as unfavorable (Baker & Baker, 2013). On the other hand, if the actual cost is less than the budgeted cost, then the result is a favorable variance. The aspect of cost variance is very important in all industries and sectors, including even the health care sector.

Strategies to Manage Budgets within Forecasts

Budgeting is a very important tool as far as planning for the use of resources in any organization is concerned, especially in cases of monetary resources. However, as mentioned above, the budgeting technique is at most times faced by the limitations resulting from the presence of variances. As a result, the management in all organizations yearning to improve budgeting accuracy must apply strategies that help in reducing the gap between the actual and the budgeted figures (Cleverley, Song, & Cleverley, 2010). There are a number of strategies to achieve this goal.

First, the management should be open-eared with respect to decision making. This means that they should listen to the employees. The rationale behind this is that the employees are in the forefront of service or product production and hence have a better understanding of the primary situation. In light of this, listening to them helps in reducing future variances.

Another strategy is considering all the factors behind budgeting. This means that, while budgeting for a certain expense, it is good to understand and consider all the factors affecting that expense. In the case of a health institution for example, budgeting for pharmaceutical products should include the consideration of factors such as competitors, new products in the market, as well as industrial regulations and policies (Cleverley, Song, & Cleverley, 2010).

The third strategy includes paying attention to the entire budgeting cycle. This means that the management should check the budget performance from time to time, not just while approving it. The rationale behind this strategy is that constant analysis of the forecasts versus the actual spending helps in controlling the range to average at the anticipated level.

Last, but not least, is the application of computer software. Actually, it should be the right software (Baker & Baker, 2013). With the current technological advancement, the management can go past using spreadsheets for budgeting purposes and apply the now available sophisticated software that are specifically designed for the calculation of forecasts and budget preparation. Actually, all available budgeting software is set to adhere even to accounting standards such as the GAAP.

Expense Aspect in the Health Care Sector

Every top management in a hospital or any other health care institution is aware of all the costs affecting their operations. Each month, they receive financial reports with data of significantly operational information such as the average cost of patient visits, average length of inpatient stays, and much more (Cleverley, Song, & Cleverley, 2010). However, even with such information, there still exist cost variances between the actual and the budgeted costs with respect to the various operations relevant in health care institutions. The figure below shows various categories of expenses in a sample hospital with the variances between their budgeted and actual results.

Figure 2

Source: (MedidaMetrics, Inc., 2013)
From the above diagram, the key expenses evaluated in the health care scenario are labor, materials, supplies, depreciation for equipments, and overhead expenses. Notably, all the five expense categories exhibit the characteristic of an unfavorable variance. The occurrence of such unfavorable variances in all these expense categories is subject to various reasons.

The labor, to start with, is a very dynamic expense category especially in a health care organization. This is because at times expert labor is called for. Unfortunately, it is not possible to forecast such since it depends on the occurrence of special medical cases that are bound to arise, which again is not possible to ascertain. Materials on the other hand are also relatively hard to ascertain accurate costs. This is chiefly because the year after year use of materials by health institution is not uniform (Cleverley, Song, & Cleverley, 2010). Unlike a processing firm where production processes are standard, the health care industry deals with diverse operations and hence the ascertainment of specific material costs cannot be made accurate with ease. The supplies also have a justification for the unfavorable variance.

The supplies in this case consist majorly of medicine, food stuff, beddings and other related stuff. Since all the supplies come from second parties, it is possible for the situation surrounding these parties to change without warning and thus resulting to the increase in actual costs over the baseline costs. Overhead expenses are not very specific. They relate to other operational expenses that fail to fall directly under one specific expense category (Baker & Baker, 2013). From time to time, the government and the government agencies may revise various operational provisions in the health care sector, resulting to increase in overhead expenses as a result.

Benchmarking Techniques to Improve Budgeting Accuracy

In the process of analyzing the expense reports, the management should be capable of coming up with benchmarking techniques applicable for avoiding or reducing budget variances in the quest of improving accuracy in both budgeting and forecasting. One technique should be setting the budgets with respect to a given strategic view point on both future operations and growth. In so doing, the revenue or the volume side of the budget should be prepared then balanced by the cost side of the budget (Cleverley, Song, & Cleverley, 2010). This way, the managers are made aware of the most accurate relationships between the current budgets with the historical performance as far as holding down costs is concerned.

Another technique is provision of training to the management about finance, forecasting and budgeting in general. Once this milestone is achieved, then the budgeting processes can be done with relatively more ease and fewer complications thus reducing variances in the long run. In addition, another applicable technique is holding variance meetings with the management and in the process discussing on the best approach towards correcting unfavorable variances (Baker & Baker, 2013). The managements then constantly checks on the progress of the underlined corrective measures. Once they have been successfully met, the actual budgeting process can be initiated with a higher surety of reaping positive results.

All the above benchmarking techniques are very easy to apply. They are self explanatory and simple to comply with. Once clearly laid out, they result to positive results in scenarios where management have off-target budgets, assisting in setting more accurate budgets, monitoring the variances, as well as managing the expenses in all categories.

Budgeting and forecasting form a very vital aspect in determining the performance and excellence of any institution. In the process of budgeting, variances occur due to differences between actual and planned costs. This cost variances may limit the success of the budgeting process. However, taking time to understand the various aspects of underlining the entire budgeting process, as well as setting up various benchmarks, helps in coming up with strategies that help to overcome the cost variances, thus rendering the budgeting process its true significance across the operations of all institutions in all sectors of operation.

References

  • Baker, J. J., & Baker, R. W. (2013). Health Care Finance. Burlington: Jones & Bartlett Publishers.
  • Cleverley, W., Song, P., & Cleverley, J. (2010). Essentials of Health Care Finance. Burlington: Jones & Bartlett Learning.
  • MedidaMetrics, Inc. (2013). ABC Reveals the True Cost of Healthcare. Retrieved February 2, 2014, from MedidaMetrics.com: http://medidametrics.com/?page_id=1411
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