Health Finance – Information that Managers need to know to Review Budgets

Budgets are critical management instruments that quantify an organization’s activities in financial terms and allow comparison of forecasted performance and actual performance. They help an entity in aspects such as controlling costs and creating organization-wide cost awareness (Baker & Baker, 2011, p. 165). For managers to review budgets effectively, they need to be conversant with the units or activities according to which total revenue generated is evaluated (e.g. number of procedures performed), how costs are allocated to such units or activities, the cost behavior (fixed or variable) of expenses incurred and the assumptions made to obtain forecasts upon which the budget was prepared. Such knowledge would help the management decipher whether variances between actual and budgeted performance result from poor performance or from poor budgetary processes thus institute appropriate action (either change the budgetary process or institute corrective measures to enhance performance).

One type of budget is the flexible budget. Unlike a static budget where budgeted costs and revenues remain unchanged throughout the budget period, the flexible budget adjusts the costs and revenues to incorporate a range of levels of activity or volume (Baker & Baker, 2011, p.173). In a healthcare organization, such a range of volume or activity levels could be the number of patient days or number of procedures. In this type of budget, costs are classified according to their behavior (fixed or variable) with an increase in activity or volume levels increasing the variable costs but not the fixed costs (Baker & Baker, 2011, p.173). The budgeted operating income for each level of operations is then obtained by subtracting the respective variable and fixed costs from corresponding budgeted revenues at each activity or volume level. The uses of a flexible budget are wide-ranging and include reviewing an unit’s prior financial performance to elucidate where change is necessary in the current period, evaluating costs that would be incurred at different activity levels and planning for changes in staffing and other resources expected with changes in activity levels (Baker & Baker, 2011, pp. 173-174).

Reference

Baker, J. J. & Baker, R. W. (2011). Health care finance: basic tools for nonfinancial managers (3rd ed.). Sudbury, MA: Jones & Bartlett Publishers.

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