Navigating Healthcare Costs: Classification, Volume, and Allocation

Like with any household, businesses have some expenses that are the same each month, and others that fluctuate based on utilization. The mortgage, car note, and insurance premiums for the most part are the same throughout the year, but the utility bills, credit card bills, and cell phone bills may increase or decrease monthly based on usage. In health care organizations, several types of cost can be classified according to the amount of services provided. This can be referred to as activity, utilization, or volume (Gapenski, 2012).

Reference for Business (2012) says, “Fixed and variable expenses are the two main components of a company’s total overhead expense” (p.1). This paper will address how costs in healthcare organizations are classified according to their volume, and the importance of cost allocation. “…for healthcare providers, a cost involves a resource use associated with providing or supporting a specific service” (Gapenski, 2012, p. 148).

With fixed and variable cost classification the range of volume should be specified (Gapenski, 2012).

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In health care organizations, the actual future volume is uncertain for the number of patient days, number of visits, number of enrollees, or the number of diagnostic tests (Gapenski, 2012). However, a general idea of the volume range over a particular period of time is usually known (Gapenski, 2012). Fixed costs are known and are not related to volume within a relevant range (Gapenski, 2012). Unless the volume deviates excessively in a positive or negative direction, fixed cost is not affected. Basu (2012) says, “Fixed costs remain constant within a specific range of activity.

However, if volume increase or decrease past certain levels, fixed cost may change” (p.1). For example, if a physician’s office staff can handle up to 10,000 patient visits, as long volume stays within the relevant range of 8,000 to 10,000 defined by the office, the fixed costs remains unchanged (Gapenski, 2012).

Although most fixed costs such as equipment, weekly payroll, and rent are fixed for a period of time, an increase or decrease in volume in the future could mandate changes/adjustments to the fixed costs (Gapenski, 2012). Fixed costs dose not fluctuate with volume changes within a relevant range, but variable costs does. “Costs that are directly related to volume are called variable costs” (Gapenski, 2012, p. 150). Reference For Business (20120 says, “Variable costs are those that respond directly and proportionately to changes in activity level or volume…” (p. 1). Using the physician’s office above as an example, some of their variable cost could be gloves, tongue depressors, disposable exam gowns, and needles. As patient volume fluctuates, the cost associated with these supplies will also fluctuate in relation to the volume changes. Because some costs are organizational and some are specific to a subunit, it is necessary to create a system that allocates costs (Gapenski, 2012).

“A critical part of cost management at the subunit level is the assignment, or allocation, of direct costs. Costs allocation is essentially a pricing process within the organization whereby managers allocate the costs of one department to other departments” (Gapenski, 2012, p. 188). Overhead cost such as, facilities management personnel, financial staffs, and housekeeping and maintenance personnel, must be allocated to the money generating departments of an organization (Gapenski, 2012). Cost allocation assigns the costs of an organization to the entities that incurred the costs. Cost allocation data allows the organization to make better decisions in, tracking, assigning, and controlling costs, as well as the offering and pricing of services. (Gapenski, 2012). Cost allocations can also assist with reducing cost, because departments are held accountable for the full cost associated with running their department. As a result, mangers will use costs saving methods to keep costs down, since evaluations, compensation, and promotions are sometimes dependent on economic results (Gapenski, 2012). Costs can be fixed or it can be variable.

“Peavler (2012) say, “Fixed costs are the costs associated with the product that have to be paid, regardless of the volume of the product you sell. Variable costs are directly related to sales” (p.1.). “…some cost are more or less predictable because they are independent of volume, while other costs are much less predictable because they are related to volume” (Gapenski, 2012, p. 150). Whether fixed or variable, costs are usually allocated within an organization. Averkamp (2012) says, “The goal is to assign the costs based on the root cause of the common cost instead of merely spreading the costs” (p. 1). Knowledge and utilization of these concepts, helps with current and future planning for an organizations financial success.

References

Averkamp, H. (2012). What is cost allocation?. P. 1. Retrieved from http://blog.accountingcoach.com/what-is-cost-allocation/

Basu, C. (2012). Effects a Sales Volume Increase or Decrease Will Have on Unit Fixed Cost. P. 1. Retrieved form http://smallbusiness.chron.com/effects-sales-volume-increase-decrease-uni...

Gapenski, L. C. (2012). Healthcare Finance: An Introduction to Accounting and Financial Management (5th ed.). Chicago, Illinois : AUPHA Press / Health Administration Press.

Peavler, R. (2012). Fixed and Variable Cost. P. 1. Retrieved from http://bizfinance.about.com/od/pricingyour product/qt/Fixed_Variable_Cost...­

Reference for Business. (2012). Fixed and Variable Expenses. P. 1-4. Retrieved from http://www.referenceforbusiness.com/small/Eq-Inc/Fixed-and-Variable-Ex...