Ch 10: Fundamentals of Financial Management

public sector

activities are maintained by local, county, state, or federal entities

private sector

activities are owned or managed by persons or organizations in non-governmental organizations

For-profit organizations

Operating as proprietary activities

Not-for-profit organizations

Operating as a social association

Proprietorship

Owned and operated by a single for-profit owner

Partnership

Owned by two or more individuals who share profits, losses, debts, and responsibilities

Corporation

A separate legal entity that exists independently from its owners (stockholders)

How do managers get reliable information to plan operations and evaluate performance?

The organization's financial accounting system via periodic financial statements is a primary source of this information capturing the necessary data on revenues, assets, and liabilities.

balance sheet

A document representing the financial position of an organization at a particular point, typically the end of an accounting period (reflects assets, liabilities, and equity).

Assets

uRepresent the resources of an organization

uCan have physical form (building) or intangible with economic value

Liabilities

The obligations that an organization has to creditors; may be short or long term

Owner’s equity

“book value” of an organization

Income statement

Presents the financial results of an organization over a stated period of time (usually monthly or yearly)

accrual accounting

Revenues are recognized or reflected in an income statement when they are earned, not when they are collected

revenue

Reflects the earnings of the organization (collected or yet to be collected)

Expense

expenses or costs are recognized as charges to the income statement as they are incurred

internal control systems

Designed to maintain a proper flow of information; reduce opportunities for mistakes; and preclude deliberate acts of fraud, theft or defalcation

cash and billing controls

Laboratory staff perform coding and charge capture.

Billing personnel submit claims.

Finance staff reconcile payments and accounts.

supply ordering and purchasing

A Pathologists' Assistant or histology supervisor requests supplies.

A laboratory manager approves the purchase.

The finance department processes payment.

The same person does not order supplies, approve invoices, and issue payments.

Purpose: Prevents unauthorized purchases and fraud.

Monthly or quarterly financial reports typically contain:

uIncome statements

uBalance sheets

uBudget projections compared to actual results

uStatistical performance reports

Managers also track financial indicators such as

uRevenues

uRatio analysis

uReturn on investment (ROI)

uInternal performance ratios

Gross charges

Total billed for services (e.g., pathology cases, specimens)

Contractual allowances/discounts

Reductions from insurance and payer agreements

Net sales

Actual revenue the organization receives

Financial reports help determine

true revenue available for operations

Liquidity ratio

Used to determine the organization’s ability to meet short-term debt obligations

Debt-equality ratio

Used to determine the organization’s ability to meet long term goals

Profitability indicator

Demonstrates the organization’s efficiency of operations

Balance Sheet and Ratio Analysis

Financial ratios can be categorized in three distinct groups: Liquidity ratios, Debt-Equity ratios, and Profitability Indicators. Profitability ratios, such as the ROI ratio demonstrate the organization’s efficiency of operations.

Return on investment (ROI)

uImportant profitability ratio used to assess performance

uUsed as a rate of return to evaluate how effectively the organization generates profit from its resources

ROI

Net Income divided by Average Equity

ROI in Laboratory Medicine

A pathology laboratory purchases a new automated tissue processor to improve efficiency:

uCost of equipment (investment): $120,000

uAnnual net financial benefit (income generated or savings): $18,000

uIncludes reduced reagent waste

uFaster turnaround time allowing higher case volume

uReduced technician overtime

uROI = 18,000/120,000 x 100 = 15% annually

uThis means the equipment is financially beneficial over time

Cost per case

uTotal supplies and labor cost divided by number of cases

uUsed for budgeting and pricing services

Stain utilization rates

uFrequency of special stains or IHC ordered per case

uUsed to monitor cost and appropriateness of testing

Specimen turnaround time

uTime from specimen receipt to final sign-out

uUsed to assess workflow efficiency and service quality

Why is financial sustainability of the lab important?

Pathology workflows directly generate billable services (gross charges)

BUT reimbursement is based on net revenue, not billed charges

Lab financial health depends on:

Efficient specimen processing and turnaround time

Accurate grossing and documentation

Workflow that supports timely billing

Goal of financial management is to ensure

efficient allocation of resources to maintain quality, efficiency, and cost-effectiveness in the laboratory

Key tools used in financial management include

budget planning

budget -performance reports

Cash flow projections

Budgeting:

A system for formalizing in writing a quantitative financial plan for a given time period

Budget Performance Report:

Compares actual vs. budgeted expenses to assess planning accuracy

Evaluates how well resources were projected and used

Helps managers review financial performance over time

Focuses on identifying variances between budget and actual costs

cash flow projection

uOperating budgets support ongoing organizational activities

uCash flow planning ensures sufficient funds to meet financial obligations

uBoth budgeting and cash flow management are essential for financial stability

Cost accounting:

Analyzes cost information to support decision-making

Helps managers identify and track costs of laboratory services

Requires itemizing all costs associated with testing and operations

Costs are classified into 4 groups

direct fixed cost

Instrument Depreciation, Proficiency Testing Materials, Office Supplies

Direct variable cost

Med Tech Staff Wages, Reagents, Lab Supplies, Specimen Collection Consumables

Indirect fixed cost

Support Services (that are static) - ex. Administrative and Supervisory Salaries, Licenses

indirect variable cost

Support Services (that flex) –ex. Training, Liability Insurance, Marketing Materials

cost behavior fixed costs

: Do not change because they are not related to volume

fixed costs example

uAdministrative salaries, rent, and lease commitments

Cost Behavior: Variable Costs

Move in relationship to the laboratory’s testing volume and change in a direct relationship to that volume

variable costs example

uSupplies and materials used to perform tests (formalin, cassettes, etc)

Cost Behavior: Semi-Variable Costs

Expenses incurred in the laboratory that vary, but only incrementally

semi variable cost example

u Lab utilities cost or instrument service contracts

Cost-Volume-Profit Analysis or Breakeven Analysis:

Determines how many tests must be performed to cover all costs

contribution margin

= Revenue per Test − Variable Cost per Test

Breakeven point

u= Total Fixed Costs ÷ Contribution Margin per Test