Overview
On the completion of this module, the learner will have gained an
understanding of:
•
The basics of budgeting including process, methods and best
practice
•
Budgeting in the context of a healthcare provider
•
Revenue and cost drivers and the basis of building a healthcare
provider budget
•
The importance of budgets to inform management
Important Acronyms to Remember
AHMAC – Australian Health Ministers’ Advisory Council
COAG – The Council of Australian Governments
NGO – Non-Government Organisation
IGAFFR – The Intergovernmental Agreement on Federal Financial Relations
CHC – The COAG Health Council
NHRA – National Health Reform Agreement
NHA – National Healthcare Agreement
NHFB – National Health Funding Body
IHPA – Independent Hospital Pricing Authority
NHPA – National Health performance Authority
Section 1
Importance of Budgeting
Budgeting is a form of risk management and seeks to ensure the financial security of future operations of the organisation. It is a key component of sound financial management.
It allows the organisation to take into account current conditions including expense, the availability of cash, amount of estimated profit / loss which then guides future decisions and policies regarding financial matters.
A budget may also identify areas of misallocation of finances in certain departments, and determine where best to allocate future expenditure.
Benefits of Budgeting
Budgeting allows an organisation to:
• Set organisational goals and monitor progress • Develop a financial road map
• Control organisational expenditure i.e. reduce, increase or maintain • Optimize revenue opportunities
• Avoid misallocation of expenditure • Ensure financial accountability
• Enable your organisation to plan for future growth and expansion
• Increase financial sustainability – Able to deliver services by covering expenditure
with sufficient income and also provide for future strategies
• Guide service priorities – Implementation (or adequate funding) of the priorities set
Accountability
Budgets are essentially plans reflecting choices based on the best information available at the time. Essentially, the budget asks; how will we do this? Is it reasonable? Does it make sense?
To build a budget, we need to understand revenue and cost drivers, and make some informed estimates. We also need to understand the impact of policy decisions and any changes to the entity’s activities. Those accountable for the budget need to understand the assumptions and information it is based upon.
Accountable Managers will be expected to justify or explain actions and decisions –
therefore the method of budgeting should ensure they take responsibility for and understand the financial expectations
Sustainability
A sustainable organisation is able to deliver its products and services in a manner where its income covers all necessary expenditure.
The notion of sustainability does not just consider the budget in the short term (i.e. 12 months), but rather, incorporates a long term view.
Sustainability
Profit and
Loss Account
Balance
Sheet
Cashflow
Operating Budget
An operating budget is detailed analysis of expenditure and revenue over a specific period of time. A budget provides financial estimates for the organisation as a whole and can also provide specific financial estimates for each department or business unit within the organisation.
Budgets should be set for all of the Primary Financial Statements (i.e. Operating Statement, Balance Sheet and Cashflow Statement).
Top-Down Methodology
Board and Executive
Director of Acute Operations
Director of Sub Acute
Operations Director of HR
Surgery Ward XYZ Hospital in
the Home Rehabilitation
Employee
Relations Payroll
• How?
• Advantages
Bottom-Up Methodology
•
How?
•
Advantages
•
Disadvantages
Board and Executive
Director of Property and
Infrastructure Director of Finance
Maintenance Project Team Supply and
Incremental Budgeting Methodology
Easy Simplicity: as the basis is a recent budget or set of financial results;
the basis can be readily identified
Stability
Operational stability is greater as departments will be funded in a consistent manner
Quick The budget can be co-ordinated relatively quickly and the impact of
major changes is easier to identify
Use-it-or-lose-it
Encourages wasteful
spending if managers think that any underspend from a previous year will adversely impact future budget
allowances
Small changes
Encourages smaller changes; however you may find that greater structural changes are needed
Status Quo
Does not encourage innovation
Advantages Disadvantages
Prepared using the
previous period’s
budget or actual performance as a basis
with additional amounts added for the
Zero Based Budgeting Methodology
Resource
Efficient allocation of resources, as it is based on needs and benefits rather than history
Waste
Identifies and eliminates wasteful and obsolete
operations
Realistic Less likely to
haveinflated budgets
Output Forces cost centres to identify
output (i.e. activity, bed numbers, medical
Feasibility
Justifying every line item may not be practical (amount of information required) Time More time-consuming than as all information is new Training Advantages Disadvantages
Every line item of the budget must be approved (not just
the changes)
The budget is fully re-evaluated, starting from a
Think Strategic
The financial budgets should support the plans and strategies of the organisation. An organisation will have an annual business plan and a longer term strategy.
A business plan is a formal statement of business goals, reasons they are attainable, and plans for reaching them. The budget should be a financially reflection of the business plan and incorporate both short-term and long-term financial plans.
Short-Term Financial Plan
• This is a financial plan outlining investment and other financial goals for the coming financial year. It typically has less uncertainty than longer term plans. The short-term plan should reflect what the health service plans to do within the next financial year, reflected in the Statement of Priorities.
Long-Term Financial Plan
• This type of financial plan covers two or more years (in practice these typically cover 5 years). These plans usually have a higher degree of uncertainty as assumptions and factors influencing the budget have more time to fluctuate.
Understand Roles and Responsibilities
One of the first steps involved in budgeting is to define the system of management processes and structures that help steer how the budget process operates. It is important to understand the frameworks you are required to operate within, for example:
Statement of Priorities: The amount of activity and the correlated funding is set out in the Statement of Priorities, which the health service’s Board formally agrees to. The Statement of Priorities is a contract between the Minister for Health and the health service.
Business Rules: Define the approach taken to budgeting, establish the rules on how to compile and build the budgets. The Business Rules also help the governance committees to maintain focus on what is most important in the budgeting process.
Define decision-rights and accountabilities. The participants in the governance structure should have a clear understanding of their roles, what areas they have decision-making authority over, and what they are expected to accomplish.
Steps from the Ground-Up
Timetable
Communi cation
Approval
• Develop and communicate budget business rule
• Set expectations
• Align with Strategy
• Follow delegated authority (from Scheme of Delegation) to develop and approve the budgets
• Executive Approval
• Finance Committee recommends that the Board approves the budget
• The Board signs the Statement of Priorities
Budget Inputs
The main inputs and considerations related for formalising a budget include:
• Capacity • Activity • Income • Expenses • Seasonalisation • Capital
Capacity
Capacity refers to the maximum level that something can either contain or produce.
In the setting of healthcare provision, capacity refers to areas such as:
• Bed numbers – how many beds are available for inpatients
• Staffing resources – whether there are sufficient nurses to staff new beds
• Clinics – whether there are sufficient clinics to support referrals
• Theatre utilisation – availability of sessions in theatre space
• Optimisation of medical equipment – for example, the number of available
hours on a Digital Radiography unit that will be available to increase capacity for more X-ray activity
Dermatology clinic Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15
Weeks in month 4.43 4.43 4.29 4.43 4.29 4.43 4.43 4.00
Base monthly sessions (p/wk) 4 17.71 17.71 17.14 17.71 17.14 17.71 17.71 16.00
New clinic opens 4 17.71 17.14 17.71 17.71 16.00
Clinic Christmas closures -35.43 -17.71
Sessional activity
The objective of activity when it comes to budgeting, is to link costs to activity –
this will also support phasing of the budget.
The profiling of when activity will be delivered impacts directly on the timing of income and expenditure, as can be seen in this example.
Revenue refers to all the money a company takes in from doing what it does –
through producing goods and/or providing services.
Income is the amount of revenue earned by an organisation within a specific period. For Government funded healthcare providers, policy and funding guidelines set the key requirements for earning income. Such documents establish the details for how the Government will fund the provider, which is generally in the form of grants for activity and block funded services.
The following are some examples of typical health service revenue streams:
• Acute grants
• Sub Acute grants
• Mental Health grants
• Outpatient grants
• Block grants
• Commonwealth grants
Other revenue streams received by a health service may include:
• Private patient fees
• Payments for services rendered outside of Government funding
• Donations (e.g. philanthropic funding, bequests, volunteer initiatives)
• Payments for medications from in-house pharmacy
• Research and clinical contracts
• Interest received from investments
• Commercial income (e.g. car parking)
It is essential to understand the drivers of the various income streams and how this will impact on the potential for future revenue.
Activity Based Funding
ABF is the system by which governments can fund their contribution to public hospital services. ABF is used to monitor, manage and administer the funding of health care provided by public hospitals.
Government health funding guidelines are often subject to change with changes in government and government policy.
For example***
$000
Revenue from Operating Activities 75,226 Revenue from Non-Operating Activities 227 Employee Expenses (53,663) Supplies and Consumables (11,267) Other Expenses (9,378)
Net Result Before Capital & Specific Items 1,145
Capital Purpose Income 6,875 Depreciation & Amortisation (7,386) Expenditure Using Capital Purpose Income (1,570)
Example of Operating Statement
Operating expenditure is a category of expenditure that a business incurs as a result of performing its normal business operations.
Accounting Standards require
organisations to report and
Operating Statement. Operating expenditure is reported here. An example of operating expenditure is highlighted in yellow
In Victoria, the format for the presentation of annual reports is divided into two sections: Report of operations, and financial statements including explanatory notes. To read further about Victorian health services model annual report, follow the link.
Link - http://www.health.vic.gov.au/anrep/ https://www.forgov.qld.gov.au/sites/default/files/annual-report-requirements.pdf http://www.dpc.sa.gov.au/__data/assets/pdf_file/0019/18190/PC013-Annual-Reporting-Requirements_2016-17.pdf https://www.treasury.nsw.gov.au/information-public-entities/annual-reporting http://digitallibrary.health.nt.gov.au/prodjspui/bitstream/10137/1417/4/Annual%20Report%202016-17.pdf
A Healthcare Provider will incur various types of expenditure in a financial period, typically these include areas such as:
• Salaries and wages – The cost of employing doctors, nurses, pharmacists, administration staff,
scientists etc. This will include the salary paid to the employee as well as ‘on-costs’
• Medical supplies and consumables – This could cover the cost of a prosthesis for example,
which is a major expense category, and smaller disposable items such as needles and gloves
• Drugs – The cost of supplying the drug for patients
• Maintenance – Contracts to service and maintain high value medical equipment, such as a
linear accelerator that delivers radiation to cancer patients
• Administrative – All organisations will have administrative expenditure, which can include
things such as the purchase of paper and pens, through to auditors or legal expertise
• Other – Other major expense items can include things such as insurance, utilities, hotel/food,
catering etc.
In Victoria for example, the categories related to the reporting of expenditure are stipulated by the government and are reported uniformly across health services within the Common Chart of Accounts, which can be viewed at
Typically, salaries and wages account for approximately 62% of expenditure budgets within major hospitals.
The basic mathematical formula for cost is:
• Price x Quantity
The cost of salaries and wages can therefore be written as:
• How much someone is paid (plus on-costs) x Number of staff (EFT)
On-costs should be considered as part of salaries and wages as they are
a cost that an employer has when they employ someone, in addition to
the cost of paying the person's salary.
Click here to read further about on-costs
It is also important to consider the factors that can influence annual
wage changes for staff, from Enterprise Bargaining Agreements (EBAs)
to government initiatives to support staff working in rural areas in
order to avoid a scarcity of qualified professionals.
Follow the link to read further.
Annual Leave entitlements differ according to the relevant award (4, 5 or 6 weeks). Most budgets assume annual leave entitlements will be taken each year, for example cost = 48 weeks paid plus 4 weeks leave accrued.
Accrual accounting recognises the cost of an item when it is incurred, not when it’s paid (i.e. cash accounting). Therefore, accrual accounting recognises leave entitlements as they are earned and keeps track of the entitlement (i.e. liability or obligation to pay).
The organisation needs to provide for eventual payout, with liability calculated by taking the hourly entitlement at the current rate of pay.
Any award increases add to the health service’s liability (obligation to pay). For example, accumulated hourly entitlements such as Annual Leave (AL), Accrued Days Off (ADO) and Long Service Leave (LSL) are calculated at current (higher) rate of pay. Therefore, the cost increases each year. When employees do not take their leave, the health service costs are for 52 weeks paid plus leave entitlement not taken, i.e. 56 weeks cost.
Sick Leave
• This is an accumulated entitlement which is not paid out upon termination of employment.
• Accrual accounting recognises Sick Leave as it is paid. Hourly entitlements are tracked, but not paid on termination, therefore there is no associated liability.
• There is no additional cost associated with Sick Leave unless backfill occurs, as it is paid in place of ordinary pay.
Long Service Leave
• The legal liability starts at 10 years service.
• Accounting liability starts at 1 year and is based on a series of probability factors and bond rates – it is very complex.
• Long Service Leave is accrued and accounted for. Accrued Days Off
• This applies to full time staff only and has similar issues to Annual Leave.
• Some staffing groups are entitled to Accrued Days Off and Rostered Days Off.
The following is an example of the impact of leave on cost in a clinical environment.
Hospitals provide 24 hour services, for example a particular ward will be open 24 hrs a day, 7 days a week. Each nurse on the ward will have an annual leave entitlement. However, when they are on leave they will need to be backfilled so there is a nurse available to look after the patients in those beds.
Assuming nurses are entitled to 5 weeks leave, the Nurse Unit Manager can plan this into the roster and recruit a sufficient number of nurses. (To cover 1.0 EFT nurse, you will actually need 1.1 EFT).
Along the same lines, if a nurse calls in sick for a shift then this shift must also be covered. However, it is obviously difficult to roster nurses on to cover sick leave due to its unpredictability. This type of leave is therefore likely to be covered at a premium cost in the form of overtime or agency etc.
It also follows that high levels of sick leave will result in more EFT at premium cost (increased price x increased quantity).
A large part of health service expenditure comes in the form of patient-related and other expenses. Some examples of these include:
• Medical and Surgical Supplies
• Prosthesis
• Administration Expenses
• Maintenance Contracts
When setting a budget, it is imperative that one has a broad understanding of the range of expenses that exist within their health service, and whether they are considered fixed or variable. The impact of CPI will need to be incorporated in the budget estimations.
Fixed Costs
• Fixed costs remain unchanged for the accounting period, and can be
budgeted based on known contracts and supporting schedules.
Variable Costs
• These are often linked to variances in activity within the health service, and
should be estimated based on the activity to be undertaken.
Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15
Days 365 31 31 30 31 30 31 31 28
Basic Pay $60,000 $5,095.89 $5,095.89 $4,931.51 $5,095.89 $4,931.51 $5,095.89 $5,095.89 $4,602.74
Sick Leave (5%) $2,500 $212.33 $212.33 $205.48 $212.33 $205.48 $212.33 $212.33 $191.78 Gross Salary
Annual Leave $6,100 $518.08 $518.08 $501.37 $518.08 $501.37 $518.08 $518.08 $467.95
Penalties $6,000 $509.59 $509.59 $493.15 $509.59 $493.15 $509.59 $509.59 $460.27
Pub Holiday Penalties $1,200 $108.00 $216.00 $216.00
Superannuation $7,201 $611.59 $611.59 $591.86 $611.59 $591.86 $611.59 $611.59 $552.41
Monthly
Seasonalisation is the process of profiling or scheduling the budget according to ebbs and flows of known trends. For example, linking activity to annual trends, such as increased bed numbers during winter.
This table shows an example of seasonalisation of basic salaries and wages costs. As can be seen, there are differences in costs month-by-month, dependent on the number of days in the month and where public holidays fall.
Capital Expenditure incorporates funds used to acquire assets such as hospital equipment, buildings, extensions and new flooring.
Capital budgeting is required for cash flow management because if you need a new machine, you need to ensure that the cash reserves are adequate to enable its purchase.
Once the purchase occurs, the annual depreciation amount of the capital item is then depreciated, which is reflected in the Operating Statement. This depreciation should also be budgeted for as part of capital budgeting.
As part of the governance and business cycle, it is critical to measure performance and communicate this to management and across the business. The objective is to provide information for decision-making by monitoring against the annual budget through month end reporting.
It is important to also manage by exception, which means to focus attention on areas where the actual and budget misalign. The numbers tell a story about
activities and operations – managers will also need to understand and tell this
story.
Ask yourself – are we making the best use of our resources to treat as many
patients as well as possible?
Undertaking regular forecasting with budget-holders will provide an estimate of where you think you will be on 30 June against the budget.
Forecasting should be based on the best info available at the time and will allow the Executive and Management Team to make an assessment on what action is
required – pull back on discretionary costs if unfavourable or prepare for
end-of-year operational spend if favourable.
Forecasting results should also be provided to the Board as they will provide insight into the future business objectives and strategy.
