Financial Guideposts for Healthy Medical Practices

June 16, 2015

Ever since the introduction of Managed Care concepts, physicians have been outgunned by the insurance carrier’s ability to dance around the issue of cost with relation to fixed fee schedules. In the past, the physician had to perform long and mostly inaccurate calculations in an attempt to figure out what it cost to perform a particular procedure and whether the proposed managed care fee schedule was fair to their bottom line.

With a Cost and Profit/Loss Analysis module, we can produce a set of reports that shows, by each procedure code, the following information:

  • Annual Frequency
  • RBRVS Individual Units
  • Total RBRVS Units
  • Total Billed Amount
  • Billing per Unit
  • Total Receipts (Collections)
  • Collections per Unit
  • Average Cost per Unit
  • Profit or Loss per Unit
  • Break Even Fee

This information is very powerful when it comes to preparing the practice for managed care negotiations. Knowing what the break-even fee is for each procedure based upon RBRVS costing techniques provides a justifiable and standardized method that may be used by the practice to defend it’s position on individual fee amounts.

It also identifies consistency levels for comparison of one procedure code to another. It allows the practice to compare its collection rate to its expense rate. It identifies, by procedure code, whether they are making or losing money and how much profit or loss there is by unit and by year. This information, if properly tracked, can also help the practice to measure their cost ratios on a month-to-month basis for comparison with financial goals and budgets.

The fact is, the RBRVS is here to stay and while there is still a reasonable fee for service component, more and more managed care providers will be depending upon the RBRVS to negotiate fee schedules. In many cases, it will also be used to monitor reasonableness of costs. These factors are more significant the higher the managed care mix in the practice. Between the E/M utilization review and the Cost and Profit/Loss analysis, the medical practice will be in a healthier financial position for the future. This will be supported through the ability to track and manage its costs and fee levels and to benchmark the practice using the RBRVS database.

Today’s physicians are expected to practice medicine and run a business. Naturally, many doctors would rather concentrate solely on the clinical health of their patients. However, physicians would be wise to pay attention periodically to some important guideposts for the financial health of their practice.

Physicians are ultimately responsible for the financial health of their practice. Some doctors get more involved than others in the day-to-day operations of their practice; more likely, a doctor delegates that responsibility to the practice administrator and/or CPA consultant. Whatever the approach, a practice must accumulate information on a daily, weekly, and monthly basis.

Daily and Weekly Monitoring

On a daily basis, a practice needs to monitor cash on hand, receipts and disbursements, managed care write-offs, and cash received at the time of service. This allows for management of cash needs, timely appeals to third party payers as required and collection of deductibles and copays from patients.

Patient payment activity should be reviewed on a weekly basis. The older these accounts become, of course, the more difficult and costly they are to collect. A weekly status report on these accounts allows a practice to make timely decisions regarding write-offs or placements with collection agencies.

Monthly Monitoring

Monthly reports produce a broader financial perspective of the medical practice. Year-to-date income and expense reports statements can identify any variances from the previous year. Significant differences should prompt an examination, along with gathering data on industry averages for that type of practice.

Accounts receivable should also be monitored monthly. Accounts over 60 days old should receive special attention, with appeals or corrected claims filed with the payer as quickly as possible. Medical practices should strive for no more than 15 percent of accounts receivable in the 90 days and over category. This is a very reasonable goal to achieve for practices with good collection policies and proper staffing in place. Gross and net collection and accounts receivable turnover ratios should also be analyzed monthly.

Analyzing Charges and Collections

Gathering financial data is one thing, analyzing data to determine the financial health of a medical practice is quite another. A good place to start is to consider information on charges and collections. Mature medical practices should reflect consistent numbers throughout the year; newer practices should have charges and collections growing each month. If these numbers shoot up and down each month, then problems could exist.

The most critical component in analyzing collections is determining an appropriate fee schedule for the practice. Some physicians do not bother developing their own fee schedules; rationalizing managed care and Medicare rates are fixed anyway. If this is your approach, you are leaving a significant amount of income on the table. More importantly the practice must now be able to determine the respective costs of delivering care that is associated with each CPT code listed in their fee schedule and the credibility of those calculations are dependent upon a scientifically sound fee schedule.

Analyzing Costs

Establishing a scientifically appropriate fee schedule will maximize the indemnity insurance portion of the business, as well as provide an accurate baseline for determining true usual and customary (UCR) charges for each procedure. Knowing the true UCR data, combined with calculating your own cost allocations and break-even amounts per CPT code, is your most effective tool for managed care contracting, evaluating existing plans as well as renegotiating those plans that are no longer profitable because of severe increases to your medical mal practice insurance premiums.

If the practice does not know the cost for each CPT code and its UCR counterpart, then it is impossible to ascertain acceptable reimbursement amounts for those procedures. A thorough Resource Based Value Scale Analysis, utilizing practice specific information obtained from the recommended monitoring procedures described above, will afford the practice the opportunity to make solid business decisions and evaluate whether accepting a plan will or will not be profitable for the practice.

Putting it All Together

Cost accounting techniques take on a number of different forms. In fact, entire books have been written about the topic. Cost accounting can be studied at the financial level, the managerial level, the applications level and so on. Our focus will be on its relationship to the revenue base of the practice, line item procedural relationships and overall costing of procedures and services. We will concentrate on using the RBRVS as a tool to compare utilization levels, resource allocation, profit and loss levels, common costing and other bits of critical information for the practice. This will be studied from both a macro level (global amounts such as total billing, collections, etc.) and on a micro level (per procedure and per unit comparisons). When we have completed the data collection and analysis portion, we will examine some practical applications for cost accounting analyses.

Data Requirements

The following data is required for each procedure code / modifier combination:

  • Annual Frequency
  • RBRVS Individual RVU (geographically adjusted)
  • Total RBRVS Units
  • Total Billed amount

The following data is required for the practice

  • Total RBRVS Units
  • Total practice expense
  • Broken out by category (fixed, variable, etc.)
  • With and without physician compensation/distribution
  • Average collection as a percent of gross charges

To begin this analysis, we need to have a complete fee schedule, including, for each procedure, the fee charged and the annual frequency. We will also need a complete listing of each of the RVU components contained within the RBRVS for each of the procedure codes and the GAF amounts for each component.   Then, we will need to obtain from the practice their collections as a percent of gross billing and their costs as a percent of gross billings.

A Word About Practice Costs

One of the downfalls of using an established data set like the RBRVS is that not every procedure code has RVU values. This means that we may not be able to include every code in the analysis database. For example, many of the pathology/laboratory codes (80000 – 89999) do not have established RVUs, excluding them from inclusion in the spreadsheet. The problem is that there may be a substantial cost associated with these procedures and therefore if the revenue is not also excluded, the analysis may become very skewed. One of the reasons we use the cost as a percent of the gross billing is that it allows us to make the assumption that the total practice costs are at least somewhat evenly distributed across all service categories. Then, we can apply that percent to the total billing amount reported only among those procedures that have an associated RVU.

The other issue involving exclusion of codes from the database has to do with procedure codes that represent services with variable costs (i.e., certain modified procedures) or those that are directly related to the cost of the product represented by the code, such as supply codes (99070 and HCPCS codes) and drug codes (HCPCS Level 2 ‘J’ codes). For the most part, these types of codes are priced based upon either regulatory models (for Medicare and other Title XIX programs) or by a cost-plus-markup methodology and therefore have a direct relationship with respect to costs that is independent from the RBRVS model. Administration of some of these codes also involves a practice expense but is usually reported using an associated code, such as a 90788 (injection of an antibiotic).

A Word About Expense Categories

There are several ways to determine expenses and it is important to involve the practice’s CPA or financial manager in this process. For the purpose of performing the cost analysis, expenses are broken down into four categories:

  • Fixed expenses, which include staff salaries, lease payments, rent, utilities, etc.
  • Variable expenses, which include those expenses that are directly linked to patient visit and volume, such as surgical kits, table paper, charts, gowns, etc.
  • Direct expenses, which represent expenses that are directly attributable to a specific provider. This might include malpractice insurance, a leased vehicle or specialized medical staff.
  • Owner compensation, which normally includes those compensation expenses above and beyond a reasonable salary for the physician owners of the corporation and bonuses distributed to both owners and non-owners.

Building the Spreadsheet

In order to begin, it will be necessary to set up a spreadsheet on your computer or by using a graph ledger. In the first few columns, put the procedure code with modifier if any, the fee amount, the annual frequency, the adjusted RVU, the total fee amount, the total RVUs , the Medicare Fee Schedule amount and the conversion factor.

  • Table 1-1: The Cost Accounting Spreadsheet

CODE TABLE PDF

Code: This is the procedure code/modifier group to be analyzed

FEE: Contains the current commercial fee charged for this group
MFS: Contains the current year Medicare fee schedule amount obtained by multiplying the Adjusted RVU times the current year Conversion Factor
Freq: Contains the annual (or annualized) frequency for this group
RVU: Contains the total geographically adjusted RVU for this group
CF: Contains the conversion factor for that group calculated by dividing the RVU column into the FEE column
TOT_FEE: Contains the gross charges for this group calculated by multiplying the Fee times the Freq columns.
TOT_RVU: Contains the grand total geographically adjusted RVU calculated by multiplying the RVU times the Freq columns

Totaling Fees and RVUs

The next step is to grand total the line item totals for the fees and the RVUs.

Total billed for the Fee Schedule

At the bottom of the total billed (TOT_FEE) column, get the sum of all of the procedure codes to get the Total Billed amount for the fee schedule.

Total RVUs for the Fee Schedule

Next, total all of the procedural RVUs to get the total RVU for the fee schedule.

Calculating Expense Percent

This is where we apply the concept discussed above concerning the determination of prospective costs based upon the actual expense percent of the gross charges. So, take the commercial fee times the frequency to get the total calculated charges. Then, divide the total expense amount by the total calculated charges. Then, multiply that same expense percent by the total gross charges within the sample set. This will equal the cost of generating the charges for those services contained within the sample set.

Example of Expense Percent

  • The practice generates $300,000 in charges
  • $181,897 are calculated as expenses
  • Divide expenses into gross charges
    • $181,897 / $300,000 = .606 or 60.6%
  • $223,384 in charges are represented in the data set
    • $76,617 in procedures do not have RVU values
  • Multiply the represented charges by the expense percent to get the dollar cost for the sample set
  • $223,384 times 60.6% = $135,443

Cost per RVU

Get the Cost per RVU by dividing the expense amount for the fee schedule by the total RVUs for the fee schedule. In this case, we would divide $135,443 by 4,455.82

Cost Per Occurrence

Contains the projected cost for each code group. This is calculated by multiplying the Cost Per RVU times the RVU for that group

The other situation that may occur is that the practice may have a management system that tracks actual or average collection by procedure code. If this is the case, then simply replace the collection amount calculated in our examples using average collections for the practice with these more accurate values.

Collect

Contains the collection amount for that group, however obtained. Normally, at least for our example, collection is calculated as a percent of gross charges by simply dividing the gross revenue (or collected amount during the sample period) and dividing by the gross charges. Sometimes, however, there are situations that exist that can significantly skew this calculation. For example, if the practice engages on a first time aggressive collection effort, they may reduce A/R by significantly increasing collections. The problem is that this increase in collections may be a one-time event and may not reflect the revenue for codes billed during the data period in which the gross charges were generated. The opposite may also occur if the practice experiences a significant increase in A/R for some reason.

P/L

Contains the Profit or Loss for this procedure calculated by subtracting the cost per unit from the collection per unit to determine if there is a profit or loss for each procedure.

Total P/L

Contains the total profit or loss for this group calculated by multiplying the P/L times the Freq columns.

Calculating Break-Even Fees

The break-even fee is the amount that needs to be charges by the practice in order to cover the cost or providing the service as the current collection rate. For the purpose of managed care, however, the break-even fee would be considered the cost factored for any risk withhold under the contract. To get the break-even fee, divide the cost per occurrence by the collection percent.

Calculating Resource Allocation

Once the final table is complete, it can be used for a number of additional analyses. One important function is to sort the table by total RVUs. This is referred to as a resource allocation table. It allows us to see which procedures in the practice consume the greatest number of resources. When calculated by physicians and or locations, it allows us to determine the profitability for each segment by developing production/consumption ratios.

Application to Managed Care

The cost accounting model is useful for other applications besides just internal benchmarking and cost control.   Performed properly, the results of the cost accounting analysis can be successfully applied to managed care models. The data from this analysis can be used to analyze cost shifting with respect to payer mix, for example. This allows the practice to determine the importance and survivability of payer models within the managed care contract proposal. It can also be used to determine break points with respect to a change in patient volume. For example, at what point in additional patient volume will the practice have an increase in costs as a result of that increase? Examining issues like marginal cost per patient as it relates to optimal v maximum capacity is important for determining actual cost components to use based upon the type of MCO offering the contract, such as PPO v. HMO.   In this case, we might use total fixed and variable costs for the PPO but only the variable costs for the HMO, provided the volume supports an existing break-even level of patient visits.

Shift in Payer Classification

In a proposed contract, it is possible to calculate the number of patients expected to be treated at the practice as a result of the contract. It is not correct to assume, however, that all of those visits will be new visits. When a managed care carrier comes into a market, they inevitably take market share from other existing payers, in addition to possibly getting new, previously uninsured members. It becomes important to be able to estimate the number of contract visits that will comprise existing payers shifting carriers as opposed to the number of new, additional office visits. The importance will become evident as we examine the methods for calculating variable and marginal practice costs.

Expected Change in Patient Volume

In any practice, there is patient visit level that is optimal for the practice. For example, a practice may be funded and staffed to handle 28 patients a day, or 5,600 patients a year. If the practice currently sees 2,500 patients a year, then there is the potential to more than double the volume without adding additional staff, equipment or physical space. Let’s say that the practice signs a contract that will add 2,000 additional patient visits a year in new volume. This will not cause an increase in operating expenses and therefore only the variable expense need be considered. If, however, the contract were to generate 4,000 new visits a year, it would be necessary to add more staff, equipment and possibly more physical space. In this case, the additional expense would have to be figured into the contract cost.

Marginal Cost per Patient

It is this calculation that causes practices to pass up profitable capitation contracts. If we have a practice that has an annual expense of $200,000, when they see the first patient, the average cost per patient visit is $200,000. On the second patient visit, that number drops to $100,000 per patient visit. After the fifth patient, it drops again to $40,000 per patient visit. At the 2.500th patient visit, the average patient visit amount is now down to $80. The next visit, number 2501, calculates to $79.97 per patient visit. How much then, did this additional patient cost with respect to the annual expense? Only three cents. Many consultants believe that a practice must receive at least the average cost per patient visit when this number is greatly inflated compared to a profitable contract amount. While this is good to illustrate the importance of understanding the concept of marginal expense, expense should be calculated per RVU, not by patient visit.

Variable Cost per RVU

In this step, we want to calculate the average cost per RVU in order to redistribute this amount to calculate the total cost of performing the procedure. Variable expenses are variable based upon the type of procedure performed and the number or procedures performed. The reason we use variable expense is that it measures the actual incurred cost of seeing a patient as opposed to the average cost per patient visit. If the contract will generate so many new visits that additional expense is to be incurred, that expense should be added to the variable expense as it is a direct result of the proposed contract.

KNOWING THE NUMBERS

In today’s volatile medical market, it’s critical for physicians to know the numbers on their practice. By paying consistent attention to these numbers, doctors can not only survive but plan strategically for the future of their medical practice. Much of what has been presented here may seem overwhelming but it is doable. While the process is tedious and complex, the concept is simple: know what it costs for your products and services so you’ll know what to charge. While many practices are just focused on survival, I submit that that is too low a goal. Using the techniques discussed here, a medical practice should be able to flourish.

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