Cost allocations; you're doing it wrong... or right... really you pick: Forward Slash Health Newsletter Issue 47
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Weekly Insight Session
There are few more sinfully satisfying feelings than succumbing to the deep, bone-level tiredness by allowing your eyes to close during a managerial accounting class. The problem is, you probably missed the whole part about cost allocation, cost pools, and…
Wait, wake up!
Ok, I will make this quick, because, well, accounting.
Imagine this…
It’s the end of the month, your fingers have indentations and are numb from all the finger crossing you have been doing before you receive the month end numbers from your accountant.
To your surprise, things are… surprising.
You worked as hard as ever, but profit just isn’t quite what you expected. We’ve seen it a hundred times.
Here’s the annoying part: Now what?
Usually you go yell at the revenue cycle team. Sometimes you look at all your expenses and don’t see anything to cut. Then, you go back to the finger crossing.
What we’ve got here is… failure to allocate. (Cool Hand Luke reference. You’re welcome).
Without allocations, you don’t know what activities are contributing to your profit margin. Or reducing it.
Because while you know you have a whole lotta 99213 office visits, what you may not know is that for the last month they have been contributing a negative margin.
Why?
Your payer mix shifted recently to your lowest commercial plans, your PA was on vacation so you were seeing most of the RTOs, and as a result each visit cost more than normal.
Knowing this information is about cost allocation.
Assigning your labor costs to a specific activity.
But don’t stop now!
What about supplies? What about electricity? What about the billing team? What about the cost to clean that fish tank you have in the waiting room?
Coral doesn’t just clean itself.
At the same time, you have a decision to make. And this is key.
You run the risk of over allocating costs to make a service look less profitable. Or maybe you allocate too little cost to make a service look unprofitable.
This is exactly why the hospital is always telling people how unprofitable certain things are. They have an expense and allocation problem.
It’s expensive to run a hospital. And complex. So they pool costs by cost center and then assign weights to your service line or department. Then they divvy up the cost.
Here’s where it goes wrong though.
Let’s look at RCM as an example.
Compare an ortho service line to primary care. Ortho is generating far more charges and collections. So, if we were to say allocate based on revenue, we would assign a significant amount of RCM expense to the service line.
But, they may actually generate less total claims than the primary care service. It’s just that primary care has far lower charges and collections per claim.
So while a per revenue basis may not work, you could allocate costs on a per bill generated basis.
The other issue is deciding what costs to allocate in the first place.
The short answer is you can allocate whatever you want. It’s all about the questions you want to answer.
My favorite approach is bifurcating expenses into expense buckets that are required to deliver care. Things like physician time, instruments, clinical equipment, your emr, etc.
The other bucket is everything else, lovingly called administrative expenses. Because when you start allocating administrative expenses it can create real challenges when managing profitability.
This way you are triangulating more of a gross margin by calculating variable and fixed costs and then looking at the whole business when you layer admin costs on top for net profit.
What you can do this week:
Look at your costs and assign them buckets. Tie those buckets to service or even at the CPT code level.
Then you will have a better perspective on profitability of each service.
P.S. We built the Forward Slash /CFO specifically for this reality.
It’s a financial platform that gives you CFO-level insights without the CFO-level salary. And if you have a CFO, amazing. Larry can totally use this tool to escape spreadsheet heck. Budgeting, forecasting, unit economics, cash flow, operational metrics all in one place.
Because most practice management software was built for billing, not for business intelligence. And most accounting software was built for accountants, not for practice administrators trying to make decisions.
/CFO bridges that gap.
Check out what the /CFO platform can do for your practice! (This is a link by the way. Yes the whole thing… all the underlined bits. Just click anywhere).
Wrapping Up
You can allocate whatever you want, to whatever you want.
It’s all about the questions you want to answer and your approach to getting them. Allocation is as much about thinking through the implications as it is about math.
P.P.S. You have been reading a lot, so if you want to just jump to the demo part to stop guessing about your financial future and take control of it, there’s a button for that too:
Disclaimer: The content provided is intended for educational purposes only and does not constitute financial or legal advice. This content is not intended to create, and receipt of the newsletter does not constitute, an attorney-client relationship. While efforts have been made to ensure the accuracy of the information presented, it may not necessarily reflect the most current legal developments or regulations and does not provide a complete representation of all associated legal and compliance considerations for any given topic. Therefore, readers are encouraged to seek professional legal advice or consult with appropriate professionals regarding specific legal issues or concerns related to their individual circumstances.