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Introduction to Budgeting

Why do we Budget in Healthcare?

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Acknowledgements

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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 decision-

making

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Important Acronyms to Remember

AHMAC – Australian Health Ministers’ Advisory CouncilCOAG – The Council of Australian GovernmentsNGO – Non-Government OrganisationIGAFFR – The Intergovernmental Agreement on Federal Financial RelationsCHC – The COAG Health CouncilNHRA – National Health Reform AgreementNHA – National Healthcare AgreementNHFB – National Health Funding BodyIHPA – Independent Hospital Pricing AuthorityNHPA – National Health performance AuthorityACSQHC – Australian Commission on Safety and Quality in Health Care

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Section 1

Importance of Budgeting

Budgeting is a form of risk management and seeks to ensure the financialsecurity of future operations of the organisation. It is a key component of soundfinancial management.

It allows the organisation to take into account current conditions includingexpense, the availability of cash, amount of estimated profit / loss which thenguides future decisions and policies regarding financial matters.

A budget may also identify areas of misallocation of finances in certaindepartments, and determine where best to allocate future expenditure.

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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

out in the organizational strategy

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Accountability

Budgets are essentially plans reflecting choices based on the best information availableat the time. Essentially, the budget asks; how will we do this? Is it reasonable? Does itmake sense?

To build a budget, we need to understand revenue and cost drivers, and make someinformed estimates. We also need to understand the impact of policy decisions and anychanges to the entity’s activities. Those accountable for the budget need to understandthe 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 andunderstand the financial expectations

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Sustainability

A sustainable organisation is able to deliver its products and services in amanner 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

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Profit and Loss Account

Balance Sheet

Cashflow

Creating a sustainable budget overall

What is an Operating Budget?

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Operating Budget

An operating budget is detailed analysis of expenditure and revenue over aspecific period of time. A budget provides financial estimates for theorganisation as a whole and can also provide specific financial estimates for eachdepartment or business unit within the organisation.

Budgets should be set for all of the Primary Financial Statements (i.e. OperatingStatement, Balance Sheet and Cashflow Statement).

We will now look at some different methodologies for preparing budgets.

Top-Down Methodology

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Board and Executive

Director of Acute Operations

Director of Sub Acute Operations

Director of HR

Surgery Ward XYZHospital in the Home

RehabilitationEmployee Relations

Payroll

• How?• Advantages• Disadvantages

Bottom-Up Methodology• How?

• Advantages

• Disadvantages

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Board and Executive

Director of Property and Infrastructure

Director of Finance

Maintenance Project TeamSupply and Purchasing

Finance Dept.

Incremental Budgeting Methodology

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EasySimplicity: 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

QuickThe 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 QuoDoes not encourage innovation

AdvantagesDisadvantages

Prepared using the previous period’s budget or actual

performance as a basis with additional

amounts added for the next year’s budget

Zero Based Budgeting Methodology

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Resource

Efficient allocation of resources, as it is based on needs and benefits rather than history

Waste

Identifies and eliminates wasteful and obsolete operations

RealisticLess likely to have inflated budgets

Output Forces cost centres to identify output (i.e. activity, bed numbers, medical consultations) and directly link to planned expenditure

Feasibility

Justifying every line item may not be practical (amount of information required)

Time

More time-consuming than as all information is new

Training

Requires specific training as it is much more complex than incremental budgeting

AdvantagesDisadvantages

Every line item of the budget must be approved (not just

the changes)

The budget is fully re-evaluated, starting from a

‘blank canvas’

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Think Strategic

The financial budgets should support the plans and strategies of the organisation. An organisation will havean 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 reachingthem. The budget should be a financially reflection of the business plan and incorporate both short-termand 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 healthservice 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 budgethave more time to fluctuate.

How do we Budget?

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Understand Roles and Responsibilities

One of the first steps involved in budgeting is to define the system of management processes andstructures that help steer how the budget process operates. It is important to understand the frameworksyou are required to operate within, for example:

Statement of Priorities: The amount of activity and the correlated funding is set out in the Statement ofPriorities, which the health service’s Board formally agrees to. The Statement of Priorities is a contractbetween 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 thebudgets. The Business Rules also help the governance committees to maintain focus on what is mostimportant in the budgeting process.Define decision-rights and accountabilities. The participants in the governance structure should have a clearunderstanding of their roles, what areas they have decision-making authority over, and what they areexpected to accomplish.

Steps from the Ground-Up

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Timetable

Communication

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

• Prepare with reference to Committee meeting and reporting deadlines.

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Budget Inputs

The main inputs and considerations related for formalising a budget include:• Capacity• Activity• Income• Expenses• Seasonalisation• Capital

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Capacity

Capacity refers to the maximum level that something can either contain orproduce.

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 capacityfor more X-ray activity

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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

budget profile 17.71 17.71 17.14 35.42 34.28 0.00 17.71 32.00

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 ofincome and expenditure, as can be seen in this example.

Activity

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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 specificperiod. For Government funded healthcare providers, policy and fundingguidelines set the key requirements for earning income. Such documentsestablish the details for how the Government will fund the provider, which isgenerally in the form of grants for activity and block funded services.

Revenue

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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

Typical Revenue Items

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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 howthis will impact on the potential for future revenue.

Other Revenue Streams

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Activity Based Funding

ABF is the system by which governments can fund their contribution to publichospital services. ABF is used to monitor, manage and administer the funding ofhealth care provided by public hospitals.

PDF

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Government health funding guidelines are often subject to change with changesin government and government policy.

For example***

Keep Watch for Changes

$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)

Net Result for the Year (936)

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Example of Operating StatementOperating expenditure is a categoryof expenditure that a businessincurs as a result of performing itsnormal business operations.Accounting Standards requireorganisations to report andOperating Statement. Operatingexpenditure is reported here. Anexample of operating expenditure ishighlighted in yellow

Operating Expenditure

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

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A Healthcare Provider will incur various types of expenditure in a financial period, typically theseinclude 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.

Types of Expenditure

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

Link - http://www.health.vic.gov.au/accounts/chart.htm

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Typically, salaries and wages account for approximately 62% of expenditurebudgets within major hospitals.

The basic mathematical formula for cost is:• Price x QuantityThe cost of salaries and wages can therefore be written as:• How much someone is paid (plus on-costs) x Number of staff (EFT)

Salaries and Wages

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

PDF – On-Costs

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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.

PDF – Understanding Annual Wage Changes

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Annual Leave entitlements differ according to the relevant award (4, 5 or 6 weeks). Most budgets assumeannual leave entitlements will be taken each year, for example cost = 48 weeks paid plus 4 weeks leaveaccrued.

Accrual accounting recognises the cost of an item when it is incurred, not when it’s paid (i.e. cashaccounting). Therefore, accrual accounting recognises leave entitlements as they are earned and keepstrack of the entitlement (i.e. liability or obligation to pay).

The organisation needs to provide for eventual payout, with liability calculated by taking the hourlyentitlement at the current rate of pay.

Any award increases add to the health service’s liability (obligation to pay). For example, accumulated hourlyentitlements such as Annual Leave (AL), Accrued Days Off (ADO) and Long Service Leave (LSL) are calculatedat current (higher) rate of pay. Therefore, the cost increases each year. When employees do not take theirleave, the health service costs are for 52 weeks paid plus leave entitlement not taken, i.e. 56 weeks cost.

Annual Leave

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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.

Sick Leave, Long Service Leave, and Accrued Days Off

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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 willneed 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 andrecruit 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 isobviously difficult to roster nurses on to cover sick leave due to its unpredictability. This type of leave istherefore 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 xincreased quantity).

Impact of Leave on Cost

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A large part of health service expenditure comes in the form of patient-relatedand other expenses. Some examples of these include:• Medical and Surgical Supplies• Prosthesis• Administration Expenses• Maintenance Contracts

Patient Related and Other Expenses

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When setting a budget, it is imperative that one has a broad understanding ofthe range of expenses that exist within their health service, and whether they areconsidered fixed or variable. The impact of CPI will need to be incorporated inthe 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.

Fixed and Variable Costs

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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 Budget $ $6,947.48 $6,947.48 $6,723.37 $6,947.48 $6,831.37 $7,163.48 $7,163.48 $6,275.15

Seasonalisation is the process of profiling or scheduling the budget according to ebbs and flows of knowntrends. 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 aredifferences in costs month-by-month, dependent on the number of days in the month and where publicholidays fall.

Seasonalisation

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Capital Expenditure incorporates funds used to acquire assets such as hospitalequipment, buildings, extensions and new flooring.

Capital budgeting is required for cash flow management because if you need anew machine, you need to ensure that the cash reserves are adequate to enableits purchase.

Once the purchase occurs, the annual depreciation amount of the capital item isthen depreciated, which is reflected in the Operating Statement. Thisdepreciation should also be budgeted for as part of capital budgeting.

Capital Expenditure

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As part of the governance and business cycle, it is critical to measureperformance and communicate this to management and across the business.The objective is to provide information for decision-making by monitoringagainst the annual budget through month end reporting.It is important to also manage by exception, which means to focus attention onareas where the actual and budget misalign. The numbers tell a story aboutactivities and operations – managers will also need to understand and tell thisstory.Ask yourself – are we making the best use of our resources to treat as manypatients as well as possible?

Monitoring Actual Performance Against Budget

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Undertaking regular forecasting with budget-holders will provide an estimate ofwhere 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 allowthe Executive and Management Team to make an assessment on what action isrequired – 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 provideinsight into the future business objectives and strategy.

Forecasting

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References