ABC - learn the untapped potential of activity-based costing in healthcare finance

Perhaps no industry has undergone more tumult in the past 24 months than healthcare, where the CFO's role is changing faster than ever. As health facilities and provider networks emerge from the COVID-19 pandemic, the industry has resumed its shift to value-based care and alternative payment models to provide high-quality, cost-effective care. But shrinking reimbursements and changing market dynamics are creating a renewed focus on both revenue and expenses as well as margins, pricing, CPT mix, capital investments, and other factors. Ultimately, it's pushing institutions to get a clear picture of the true cost of care through activity-based costing (ABC).

In many industries, the cost-accounting discipline has offered a time-tested, tried-and-true method for understanding the fully loaded cost of a specific product or service that reflects associated expenses such as labor, overhead, capital equipment, depreciation, and more. Unfortunately, the vast majority of healthcare organizations lack the financial infrastructure to perform ABC accounting. The Healthcare Financial Management Association reports that fewer than 10% of hospitals and healthcare systems have advanced cost-accounting systems capable of providing accurate cost data across the entire continuum of care. Instead, they've relied on methods such as "the ratio of cost to charges."

However, with more than half of U.S. hospitals operating at a loss following the pandemic, the pressure is rising to reexamine cost structures at very granular level. And a greater emphasis on price transparency from the federal government is creating further change. U.S. hospitals must now post their "standard charges" for items and services, enabling patients to shop around for lucrative procedures such as joint replacements.What's more, CFOs must now find smart ways to implement new value-based care contracts that can entail a certain degree of financial risk, ratcheting up the pressure to understand full costs and manage within budgets to avoid losses.

How can healthcare organizations and health enterprises implement ABC and understand the true cost of care? ABC starts by identifying the activities and resources used to produce an output (including indirect expenses such as facility costs or other overheads). In a growing number of complex healthcare organizations relative value units (RVUs) are employed, making it a tall order to estimate the volume of resources required to perform each patient service. The best place to begin this analysis is by getting a handle on the three critical types of data – clinical, statistical, and financial.

Clinical data

This is the data that we think of first in evaluating the cost of care. It can encompass everything from medical records and images to prescriptions and clinical notes. For instance, a knee replacement involves numerous high-salaried clinicians as well as an inpatient post-operative stay in the facility, imaging studies, blood work, anesthesia, pain prescriptions, outpatient physical therapy, and much more. It's easy to see that all this data has a direct bearing on the cost of care and is essential to the ABC discipline.

ABC draws on electronic medical records (EMRs), treatment systems, diagnostic devices, pharmacy systems, data-capture systems, clinical records, and other clinician-facing systems.  Of course, this is protected health information (PHI) – that is, any information in a medical record that can be used to identify an individual. It's essential to share it in ways that pass regulatory muster – with role-based workflows and HIPAA-compliant security and documentation – in the event of any future audits.

Statistical

Beyond simply understanding the direct costs at a granular level, it's important to also have a clear picture of the overall capacity of your facility. How many doctors are employed? How many beds – by department or specialty – does each of your facilities have? What are the locations? What procedures are performed at each location – and what are their billing codes? How many pieces of specialized capital equipment do you have?

This data may reside in your EMR, but it could also easily be in your human resources or fixed assets systems. Once you blend this in with your clinical data, you can begin to create multi-entity, multidimensional views of data to see, for instance profitability by procedure.

Financial

ABC accounting also requires a complete view of all the overhead expenses that are traditionally tracked by financial systems. That can include data such as accounts payable and days sales outstanding (DSO), rent, reimbursement rates (by payor), vendor costs, inventories, or even something as complex as the maintenance schedules for your MRI machines and the associated retirement/replacement strategies for your capital equipment.

That data is often found in payroll/HR systems, accounting systems, EMRs, and similar sources.

Ultimately, healthcare providers will embrace advanced methods like activity-based costing because, in a post-pandemic world, traditional methods simply will not yield the big-picture visibility, the drill-down precision, or the strategic insights that healthcare organizations now require. Without the clinical, statistical, and financial data, you only have a partial view of the total cost of care.

New financial systems and integrations to EHRs and other systems will enable even smaller hospitals, physician groups, post-acute care providers, and other firms to gain agility and make more confident decisions to meet the requirements of a rapidly changing healthcare market.