LOS REYES HOSPITAL Preparing this budget requires many assumptions that I'm not the least bit qualified to make. If the hospi- tal is to have something that's realistic, I'm going to have to involve the physician chiefs and a few other key managers. The real question is how best to do that. Alex Cohn, the Chief Financial Officer of Los Reyes Hospital, was commenting on the frustra- tion he felt as he began the process of preparing the hospital's budget for the upcoming fiscal year. As a first step in the process, he had requested some basic information from each of the hospital's clinical and service departments. He continued: In reviewing this information, I realized that I simply couldn't make many of the budgetary decisions in a sensible way. So, I thought it would make sense to decentralize some decisions to the clinical and service departments. However, I know that I'll encounter some resistance in doing that since these people have never been involved in budgetary decision making before. I thought it might make sense to show them how they could become involved in a way that takes advantage of their expertise. I only hope that I'm not creating a monster of some sort! To demonstrate the potential role for physician chiefs and service department managers in for- mulating the hospital's budget, Mr. Cohn chose four case types in the department of medicine and four hospital service departments as the building blocks for a sample budget. He felt that if he could demonstrate a better approach to budgeting for these four case types and four departments, his approach then could be expanded to cover the rest of the hospital. The four case types he chose were DRG089 (Simple pneumonia & pleurisy, age over 17), DRG014 (Specific cerebral vascular disorders except transient ischemic attack), DRG096 (Bronchitis & asthma, age over 17), and DRG140 (Angina pectoris). The four service departments he chose were routine care (i.e. the hospital stay itself), radiology, laboratory, and pharmacy. Financial Information Mr. Cohn used the information he had obtained from his meetings and conversations with the the chief of medicine, Maria Delgado, M.D., to determine how many cases of each type she ex- pected the physicians in her department would treat during the upcoming year, and how many units of service she expected each case would use from each of the four service departments. Since most of the hospital's contracts used a diagnosis-based form of payment, he then dis- cussed the expected revenue the hospital would receive for each case type with his manager of con- tracting. The results of his information gathering efforts are contained in Exhibit 1. Mr. Cohn next met with the heads of the four service departments to discuss and agree on their variable expenses. Since the hospital had just completed a lengthy and extensive study of the break- down between its fixed and variable expenses, this information was readily available. He determined that the variable expenses were as follows: Day of routine care Radiology film Laboratory test Pharmacy unit (e.g., a prescription) $250 25 15 5 The final step in his analysis was to determine the fixed costs of the department of medicine. This information also was quite readily available because of the study that had been completed. He concluded that the department would have fixed costs totaling $1,950,600 for the upcoming year. These consisted of both the department's direct fixed costs and costs that would be allocated to it from the hospital's service centers (such as housekeeping, laundry, and dietary). Mr. Cohn then asked his staff assistant to use this information to prepare a budget for the de- partment of medicine for these four case types and the four service departments. He realized that this budget would not show the complete operating activities for the department of medicine, since the department treated many more case types. Nevertheless, he felt that if he could present the in- formation to Dr. Delgado in an easily understandable form, she would see its value, and would be willing to use the same process for completing the budget for the remaining cases in her depart- ment. Expected Number DRG of Cases 089 300 014 200 096 140 100 50 LOS REYES HOSPITAL (A) Exhibit 1. Budget Data Expected Revenue per Case $6,000 6,500 5,000 3,000 Expected Expected Days of Routine Care Radiology Films per Case per Case 9 11 7 4 5 6 1 Expected Expected Laboratory Pharmacy Tests Units per Case per Case 10 10 3 5 5222 55 20 12 21 DRG 089 014 096 140 Variable Expenses Day of Routine Care Radiology Film Laboratory Test Pharmacy Unit (e.g., a prescription) Expected Number of Cases Upcoming Year Fixed Costs $250 $25 $15 $5 300 200 100 50 $1,950,600 Expected Revenue per Case $6,000 $6,500 $5,000 $3,000 Los Reyes Hospital Budget Data Expected Days of Routine Care per Case Expected Radiology Films per Case Revenues Expected Days of Routine Care per Case 9 11 Expected Laboratory Tests per Case Expected Pharmacy Units per Case Total Variable Costs Contribution Margin DRG 089 DRG 014 DRG 096 DRG 140 7 4 Expected Radiology Films per Case DRG 089 5 6 4 $1,800,000 $675,000 $37,500 $45,000 $82,500 $840,000 $960,000 $670,000 $304,500 $89,750 $2,024,250 Expected Laboratory Tests per Case DRG 014 10 10 3 5 $1,300,000 $550,000 $30,000 $30,000 $20,000 $630,000 Expected Pharmacy Units per Case DRG 096 20 12 21 $500,000 $175,000 $10,000 $4,500 $6,000 $195,500 Operating Income -$73,650 DRG 140 $150.000 $50,000 $1,250 $3,750 $5,250 $60,250