June 8, 2009
Financial Benchmarking Takes on New Importance
By Elizabeth S. Roop
For The Record
Vol. 21 No. 12 P. 12
In these uncertain economic times, it has become imperative for healthcare organizations to be accountable for their dollars and cents. Benchmarking is one tool to help keep the ledger in the black.
Once considered largely recession-proof, hospitals and health systems are buckling under the strain of plummeting profit margins, shrinking reimbursement rates, and vanishing credit—all while being faced with the task of finding resources to implement new processes and technologies necessary to comply with looming regulatory mandates.
These economic realities, which are affecting hospitals of all sizes and types, have given new importance to the need for effective financial benchmarking programs. In addition to enabling hospitals to gauge their performance against comparable peer groups, regular financial benchmarking can reveal clues to how facilities can reassign resources and streamline efficiencies to achieve care objectives.
“The state of the economy and rising unemployment, and therefore rising numbers of uninsured [patients], puts financial pressure on hospitals, so they are looking at how they can improve their own internal processes to deal with that,” says Richard L. Gundling, FHFMA, CMA, vice president of the Healthcare Financial Management Association (HFMA). “With the capital markets in such flux, it’s harder to borrow money from outside, so you have to generate capital from your bottom line. … Hospitals are all trying to improve, to make sure they are operating as effectively as they can, that costs are in line … and preserving cash. These are all areas you can benchmark against.”
Absorbing a Critical Economic Hit
A March analysis of hospital finances by Thomson Reuters reveals just how hard the industry has been hit by the economic recession.
The study tracked two dozen key financial indicators, using public and proprietary data to examine the balance sheets of 439 hospitals nationwide. It evaluated trends in revenue and profit, employment levels, closures, inpatient volume, reimbursement rates, and the frequency of elective medical treatments to gauge facilities’ fiscal health. Key findings for the third quarter of 2008 include the following:
• The median total margin among the participating hospitals was a historically unprecedented low of 0%.
• Approximately one half of the facilities were unprofitable.
• Payments received from Medicare, Medicaid, and private insurers were declining.
• Median cash on hand was at a historic low.
• Restricted investment assets had shrunk substantially for major teaching hospitals.
• Though early data were inconclusive, inpatient total admission volumes may be falling below expectations.
“Hospitals are facing unprecedented economic stress, and many of the indicators we’re seeing suggest that things will get worse before they get better,” said Gary Pickens, PhD, chief research officer for Thomson’s healthcare business and the study’s lead author, in a press release. “While operating margins are generally holding steady, nonoperating margins have all but disappeared from hospital balance sheets. That makes it difficult for hospitals to secure financing for new equipment and to fund expansion efforts.”
The potential recessionary impacts of bed closures, mass layoffs, declining patient volumes, and declines in elective procedures were not yet seen in the initial data. However, Thomson researchers are continuing to closely watch key metrics, including operating margins and the frequency of elective procedures.
“If they start to slip, it may usher in a host of contagious effects,” said Pickens.
Although the current economic crisis has given it new importance, financial benchmarking has long been a key tool for helping hospitals stay the financial course and identify areas of strength and weakness. Internal benchmarking allows facilities to gauge the progress toward established goals, while external benchmarking helps them determine how their processes and operations stack up against peer facilities.
“It really gives middle managers a bellwether of where they’re at and senior managers perspective of how you stack up, not just inside the organization, but also outside,” says Kevin Burchill, Esq, FACHE, a director with Beacon Partners. “The key is that [financial benchmarking] can reveal actual discrepancies between internal performance and external, generally held expectations of what defines a quality, operationally based department or unit.”
Financial benchmarking can help facilities assess distribution of resources and justify budget increases and decreases within individual units and hospitals within a multifacility system. It can reveal whether a facility’s per-unit labor costs are higher than the norm based on admission or discharge rates. It can show where supply costs, fiscal performance, volume, and productivity stack up against those of a comparable peer group.
When facilities find numbers that deviate from the benchmark, it gives them a starting point for their investigation into why they are outside the norm—both in terms of internal benchmarks and external benchmarks from comparable peers—and the possible solutions.
Benchmarking “is necessary to help understand the trends that are taking place within the hospital and to see if there are pockets for concern that require additional investigation into performance,” says Rob Schile, healthcare principal with LarsonAllen. “In any period of significant change, the importance of benchmarking is elevated. It’s about keeping grounded on what is taking place in your organization and understanding why. There’s just no substitute for data. The key is to understand what the benchmarks showed in the most successful years and what they are showing now, the emerging trends, so that management can implement necessary changes before they hit rock bottom.”
The most critical components of a successful financial benchmarking program are credible data and a set of indicators that will tell the true story of a facility’s fiscal performance over time. Because acting on the trends identified in financial benchmarking often triggers the need for process and operational changes, buy-in from executive and even board level is also important for success.
“Top down sets the tone,” says Gundling. “Part of the culture [change] is that the financial and operational staffs have to work together. You can’t have silos. They have to work together to come up with the innovations that help streamline costs and processes and enhance productivity.”
For that reason, while financial benchmarking programs typically originate in the finance department, the most successful efforts also involve the clinical and operations managers who will be responsible for finding answers to the questions raised in the process, as well as implementing the changes necessary to bring the facility in line with expectations.
In general, financial benchmarking focuses on three main areas: profitability, liquidity, and capital structure. Data within these three areas include admissions, discharges, and transfers, as well as cash collections on the front end (eg, coinsurance and copays), days in accounts receivable, cost to collect, payroll, benefits, and materials costs. Also helpful is comparing actual vs. budgeted month-to-date, year-to-date, and against prior years, which can reveal seasonality trends.
Equally important as the credibility and accuracy of the internal data is the identification of the comparable peer group. There are numerous external data sources from which to select, including commercial organizations and professional associations and societies. Which is best for an individual hospital depends on how closely they can match a facility’s unique characteristics and market composition.
“It is pretty straightforward. Key elements to look for are organizations in similar size, complexity, and service lines,” says Schile. “For example, a hospital that has a large senior skilled nursing facility and a large medical group practice would want to compare itself to a like-kind organization rather than to a hospital that does not have those components because the indicators can show differing results.”
He notes that in LarsonAllen’s national benchmarking study for critical access hospitals, it even considers reimbursement from third-party payers in individual regions, as these types of external elements can impact conclusions about financial performance.
Burchill also recommends ensuring that the external source selected is defining data in the same way as the hospital. “Each external benchmark may define things differently, so you have to make sure you’re using the same definition of, for instance, nursing hours per day or assistant directors of patient care services. Are they counted toward the clinical hours or not?” he says. “So not only do you need to have clean data but an accurate comparison of the statistics you’re trying to measure. If you’re going to hold the middle management team responsible for doing something about the data, senior management has to be accountable to make sure that the data is not only accurate but that the definitions are accurate.”
In terms of implementing changes in response to financial benchmarking, Burchill notes that both senior and middle management have important and distinctive roles to play. Senior management must take accountability for change, but middle management must be given the responsibility for and capacity to implement it.
“The only way we can do that is to have a working middle management group responsible for the day-to-day [activities]. They should be running their unit like they were the CEO of their own business. That is the person who is able to influence the two main variables: volume and expense,” he says. “Volume covers revenue capture, and expense is controlling payroll expenses and managing supplies. It really boils down to treating those two as a numerator and denominator. It can’t be ‘flavor of the month.’ It can’t be sporadic. It has to be a consistent approach that is looked at from the top down but is managed from the bottom up.”
In addition to developing the processes and procedures necessary to implement change based on benchmarks, hospitals should implement a means by which that change is monitored to determine whether it is effectively meeting the stated objectives. If it isn’t, further evaluation is necessary to determine why that’s the case.
Also important is viewing benchmarks with a critical eye and a willingness to “not accept the status quo,” says Schile. Benchmarking must also be kept in perspective. “We hear a lot of rebuttal about comparability of benchmarking data. To me, it’s a frame of reference as opposed to an absolute,” he says. “The key to benchmarks is to pay less attention to comparability than to the trends you’re seeing within your facility.”
He points to LarsonAllen’s Critical Access Hospital Gold Standard Performance Summary as an example. In it, the firm compiled a list of attributes and benchmarks that designate “gold standard” facilities. If other hospitals implement those same elements that drive success, they may never reach the absolute indicator or benchmark value because of external factors beyond their control, but they will be among the top-performing facilities within their region.
“External forces may prevent an organization from ever hitting a specific operating margin, but compared to others in their region, those who learn from benchmarks will have stronger financial performance,” Schile says. “You’ll move performance from where it is now to a place that is substantially better, even though you may never reach the absolute benchmark number.”
And that, says Gundling, is the real value of financial benchmarking. It is not about competing with peer groups; it is about driving internal improvements to reach the highest possible levels of efficiency and fiscal performance.
“You benchmark against yourself to try to show continued improvement and set targets to better your own internal programs. Then you compare against peer groups. You look to outside organizations that may have what are considered better practices to try to improve there,” he says. “It’s not just about the number. It really is about changing and getting the organizational commitment to manage toward better practices. It is a quest to keep getting better.”
— Elizabeth S. Roop is a Tampa, Fla.-based freelance writer specializing in healthcare and HIT.