Balanced Business Decision-making for Clinical Practices:... : Plastic and Reconstructive Surgery – Global Open (2024)

INTRODUCTION

Business decisions can make or break clinical practices. Making balanced decisions that satisfy the clinical needs and create a profit is inherently difficult. It requires financial and business management knowledge for clinicians and their administrative partners. New programs have recently been launched to promote physician leadership.^1–4 This tutorial aims to narrow the gap and create a partnership between physician-leaders and their administrators^5–7to ensure superior performance, patient care, profitability, and growth.^8–11

Balanced decision-making must use three information sources:

1. Financial data, which are based on periodic and annual financial statements (FS);
2. Clinical productivity;
3. Resource utilization (RU) data.

Critical aspects of each source are explained. In the section on using financial data, we supply an Excel spreadsheet that is already populated with ratios and can be used by the readers.

FINANCIAL STATEMENTS

FS provide summary information on the financial consequences of entity leaders’ past decisions (ie, effectiveness), while their current decisions shape present and future FS. Strong financial performance creates profits and cash balances (Fig. 1), which funds recruitment and retention; helps attract investments from the hospital administration; and, in private practice, helps obtain better loan terms and fund dividend payments and new acquisitions. The most useful FS are:

• The balance sheet lists assets and liabilities. It indicates the financial position: the practice’s net worth, also known as equity, equals assets minus liabilities. Assets are things the entity owns (cash, real estate, equipment, supplies). Liabilities, aka debts, are what the entity owes others: for example, loans, payments to suppliers, taxes.
• The profit and loss statement lists revenues (inflows) and expenses (outflows, costs) over a time period. It indicates financial performance: profit equals revenue minus costs. Throughout this article, we emphasize that to increase profit (or at least not make a loss), one can either increase revenue or reduce costs.
• The cash flow statement complements the profit and loss statement by providing details of the inflows/outflows during the same period. It provides an estimate of cash (or equivalent) on hand to meet obligations should expenses rise for unexpected reasons (eg, COVID-19).

Categorization of Costs

Costs fall into different categories.^12,13

• Variable costs versus fixed costs: Variable costs (VCs) increase with the volume of sales/patients served (eg, disinfectant, sutures, dressing materials for wounds), whereas fixed costs (FCs) do not (eg, clinic rent, utilities, administrative and staff salaries).
• Direct costs versus indirect costs: Direct costs can readily be tied to specific services, whereas indirect costs (eg, administrative expenses, interest on loans, insurance payments, taxes) cannot. Most VCs are direct costs, but some direct costs may be fixed (eg, rent for the specific facility where the service is provided).

Although buildings or specialized equipment owned by a service are assets (they can be sold for cash), the depreciation on them is a direct FC. For private practices, advertising and local event sponsorship are either direct or indirect costs based on whether the entity as a whole or specific services are involved.

Financial Metrics

Metrics summarize several aspects of an entity’s operation. Based on ratios, they allow comparison of different-sized entities; small entities may be profitable, whereas giant entities may be hemorrhaging.

We provided an Excel spreadsheet in Supplemental Digital Content 1, that lists FS and computed metrics from three entities: two fictional practices, A (large) and B (smaller), and a (profitable) fictional corporation, to let the user inspect formulas, experiment with numbers, and gain deeper understanding. (See figure, Supplemental Digital Content 1, which displays the lists of FS and computed metrics from three entities. In addition, using the spreadsheet, readers can inspect formulas, experiment with their own numbers, and gain deeper understanding. https://links.lww.com/PRSGO/D318.)

Note: the last, modified from a public source, Yahoo Finance, lacks the granularity of the practices: certain rows for the practices are blank for the corporation. In public corporations’ published FS, the aggregation of revenue and cost line items into different categories is highly variable. Thus, the corporation’s revenue is not itemized, and its administrative and employment expenses for the practices are lumped into “operating expenses.”

All metrics apply to a given period: typically, a financial year (as in the same spreadsheet). However, internally, more frequent review of detailed data is needed to make timely decisions.

Financial metrics fall into three categories, discussed below: profitability, liquidity, and management effectiveness.

Profitability Metrics

• a. Contribution Margin (CM) = (Revenue – VCs)/Revenue
• b. Gross Profit Margin (GPM) = (Revenue – Cost of Services)/Revenue
• c. Net Profit Margin (NPM) = (Revenue − Total Costs)/Revenue
• d. Break-Even Point (BEP) = FCs/CM

• Profitability relates to income and expenses involved in a practice. Broadly, profitability metrics direct decisions made on financial data alone (Fig. 2). They are easy to understand and differ only in the numerator (the item subtracted from revenue).
• CM focuses on an entity’s individual service activities (eg, liposuction). All activities aren’t equally profitable, contributing differently to overall profit (hence the name). These are important for leadership to explore how to reduce each activity’s VCs or increase revenue.
• When calculating fractional contribution to overall profit, or BEP (see below), the CM formula omits the denominator, and CM is expressed as currency (eg, dollars).
• By contrast, GPM and NPM are “big picture,” applying to the entity as a whole, and of interest to investors, lenders, and regulatory agencies.
• Expressed as ratios, CM ≥ GPM ≥ NPM, because cost of services includes additional, direct FCs (eg, salaries, facility rent, and equipment depreciation, all traceable to specific services.). Total costs include indirect costs, for example, taxes and interest payments; therefore, CM can be positive, whereas GPM and/or NPM are negative. (See spreadsheet for practices A/B.)

Note: In formula c above, (Revenue – Total Costs) is also known as net income (NI). We’ll use NI in management-effectiveness metrics later.

• BEP, like CM, applies to individual activities. Therefore, the formula expresses CM in currency. Even if an activity’s profitable, sufficient patient volume must be achieved to offset FCs. The BEP is the number of service units at which FCs and total revenues are equal. Because BEP is widely used, we introduce nonmedical examples below.
• For surgery activity, service units = number of patients treated. For manufacturing/sales, it is the number of items sold. Any services/sales above the BEP represent profit.
• To reach profitability, one must either lower FCs or increase CM. With most academic entities, FCs (linked to the institution) are beyond the entity’s control. Therefore, one must increase revenue—renegotiate reimbursem*nts, increase prices (for direct paying patients), improve staff productivity—and/or decrease VCs.
• BEP is closely tied to turnover, which is the number of units’ delivered/sold per unit time. In business, well-operated entities (supermarkets, restaurants), despite modest CMs, achieve profitability through high turnover and low FCs, whereas higher-end entities may lose money.
• In surgery, skilled clinicians/surgeons comprise the highest long-term FC component. To maximize patient turnover (and reduce clinician burnout), their time must be spent mostly in surgery and clinical decision-making, while getting maximum lower-cost personnel assistance in nonrevenue-generating activities like documentation or communicating with insurance company personnel. Also consider minimizing idle presurgery/between-surgery time, if significant, by adding more surgical facilities.

Liquidity Metrics

• a. Days in Accounts Receivable (DAR) = Accounts Receivable (AR)/Days to Get Paid
• b. Working Capital = Current Assets – Current Liabilities
• c. Current Ratio (CR) = Current Assets/Current Liabilities
• d. Quick Ratio = (Current Assets – Illiquid Assets)/ Current Liabilities
• e. Operating Cash Flow (OCF) = Cash Revenue – Operating Expenses Paid in Cash

• AR means “money others owe you for already-delivered services.” All debtors do not pay you equally promptly (or in full).
• DAR, similar to financial metrics CM/BEP, must be calculated for individual debtor level. High DARs indicate late/missing claims submissions, denials, or lower and later reimbursem*nts. See our previous revenue cycle management article in this series for approaches to improve reimbursem*nt turnover.
• Liquidity measures an entity’s ability to meet ongoing and/or unexpected expenses by converting certain assets to cash rapidly, at a price reflecting the assets’ intrinsic value. Liquidity is especially relevant to private surgical practices vulnerable to external economic changes. (eg, during COVID-19, patient volume dropped, but entities needed to continue paying salaries, rent, and loan interest.)
• Cash (eg, current/savings accounts) is the most liquid asset; stocks and bonds are also liquid.
• ARs are semiliquid, based on the debtor. Also, to calculate liquidity, estimating uncollectibles should reduce AR.
• Real estate and inventory, for example, equipment/supplies (or collectibles like antiques, paintings, etc.), are illiquid: if you need cash quickly, you will have to discount them steeply to attract buyers.
• For working capital and CR, “current assets” are assets that can be converted to cash at intrinsic value within one year (when creditors can wait).
• Quick ratio is more stringent than CR: it defines the ability to meet emergent obligations within a month (to make payroll) by converting liquid assets to cash.
• OCF applies to payments/revenue in cash/equivalents. In surgery, cash revenues include patient copays, fee-for-service treatments, and insurance reimbursem*nts. Cash expenses include salaries and rents. Timely and efficient billing/collection ensures positive OCF: if not, the entity may run out of available cash despite the staff working hard. (See DAR above, and our previous article on revenue cycle management.)

Management Effectiveness Metrics

To understand these metrics, remember that equity (net worth) = assets – debt (liabilities), and that NI = revenue – total costs. Academic practices are shielded from debts, which are accrued by the institution after approval.

• a. Return on Assets (ROA) = NI/Assets
• b. Return on Equity (ROE) =NI/Equity
• c. Debt to Equity (DTE) = Debt/Equity

Explanations

ROA measures how effectively assets are used to generate revenue, particularly important in cosmetic practices with high-cost assets (laser machine, med spa services). Because debts are rarely zero, equity is always less than or equal to assets. (Large debt means negative or zero equity.) So, ROE is greater than or equal to ROA. ROE alone can mislead because, in the “leveraged buyout era,” the entity’s management can acquire a lot of debt to reduce equity, increasing RTE even if revenue is unchanged.

Here, DTE gives the true picture: although almost all corporate entities rely on some debt, DTE greater than or equal to 2.0 is ominous: with excessive debt, most (or all) revenue goes toward paying debt interest.

Limitations of Using Financial Data Alone

As financial sector advertisem*nts warn, “past performance does not guarantee future results.” FS have all the limitations of retrospective data¹⁴and may not adequately reflect an entity’s ability to handle contingencies.^15,16

Further, statements generated/presented by individuals unfamiliar with clinicians’ needs or clinical performance may rely on inaccurate/incomplete inputs. Finally, because accounting methods vary, “creative accounting” (legal-but-unethical, loophole-based practices) can mislead faculty and the team.

Some health systems do not share financial and other clinical performance data with clinicians. These restrictions harm the entire enterprise in turn. Ways to address this have been explained in a separate article in this miniseries titled, “Financial Statements.”

CLINICAL PRODUCTIVITY

Clinical productivity (CP), the practice’s mainstay, is commonly measured by specialty-specific relative value units (RVUs),¹⁷ with benchmarks from AAMC,¹⁸ or MGMA.¹⁹ Higher than expected total RVU is desirable. Note that RVUs alone can mislead because they can be manipulated.²⁰ Manipulations that cross into illegality (see Justie.gov²¹) may leave the entity financially liable for false claims. Unfortunately, these can often only be detected via close inspection of EHR rather than billing data: most successful false claims actions are brought by whistleblowers.

Analysis combining financial data and clinical-performance evaluation at both a service-activity and practice-wide level develops a composite picture, identifying (in)efficiencies and opportunities for investments for both long- and short-term CP gains. The steps of analysis are:

• 1. Identify the best/worst-performing clinical activities, using measures that will align the financial picture with the clinical activity.
• 2. Foster trans-entity collaboration and accountability by giving contributors inter-plan collaboration tools, a single source of approved data, and a process workflow that keeps all plans on track.
• 3. Consider ways of maximizing automation. It can:
• a. Efficiently track costs, units, and hours, in alignment to budget projections;
• b. Streamline submissions, revisions, and approvals;
• c. Monitor metrics through scorecards and dashboards;
• d. Refresh ad hoc analytics and reports with real-time metrics.
• 4. Categorize activities based on their meeting competitive standards, cash flow positivity, or meeting nonfinancial (educational, social or institutional) needs (Fig. 3).
  • a. Large-CM, high–cash flow, “low-end” activities, for example, med spa, fillers, Botox, cosmetic product sales, etc., provide revenue streams for departmental growth and subsidize research and education. Administrative autonomy from the medical center with independent control over its expenses helps lower costs and improves market competitiveness, and profitability. This requires a firm institutional commitment.
  • b. Low-or-zero-CM, high–nonfinancial-value activities, for example, trauma, have educational, social, or institutional gain, representing the practice’s obligations to the local community or academic research. Subsidies through a hospital’s FC mechanisms, medical school education funds, local or state government social welfare grants, or philanthropy help fund these activities. Also consider renegotiating reimbursem*nts (see Integrated Analysis, Institutional-level Steps later.)
  • Activities with neither financial nor ancillary value must be considered for elimination.

• 5. Anticipate future demand and supply: Identify lacunae in regional care services to plan growth. Measure intrapractice operation wait times (between referrals and consults, decision to operate, and surgery) to optimize resource availability and utilization (details below).

RESOURCE UTILIZATION

RU “is effective deployment and management of resources to achieve optimal outcomes.”²² This classifies resources into human (faculty/staff); financial; material/equipment; technological (eg, software, hardware, data analytics tools, and automation technologies); and time (deadlines necessitate effective prioritization/scheduling). Below, we focus on human resources, the most important in surgical contexts.

RU uses various metrics, with one common equation: actual output/potential output, where “output” is revenue, billable hours, patients seen/treated. “Potential” outputs may be accurate or guesstimates and may be unreasonable occasionally. In the 1980s at Microsoft, “death march” programmer effort estimates ignored weekends, public holidays, sick days, and vacations, and left no time to research a problem before writing code.²³ Similar overscheduling leads to clinician burnout and increases medical errors.²⁴

RU analysis²⁵ of individual activities helps estimate whether reimbursem*nts and provider compensation match the providers’ effort to deliver care. Shortfalls suggest opportunities to renegotiate reimbursem*nts or refocus activities and include inadequate compensation (requiring pricing readjustment) and inefficient resource allocation to individual activities: for example, RU improves if a lower-cost physician assistant performs most postoperative follow-ups rather than a surgeon.

Sample RU Metrics and Interpretation/Application

• a. Template Utilization Rate (TUR) = Total Filled Clinic Slots/Total Available Clinic Slots
• b. Clinician RU = Total billable hours/ Total Available Working Hours

A low TUR affects revenue/profits adversely. The standard practice of repeated reminders to patients (who are likely to forget appointments made months ago) close to the appointment date maximizes TUR.

By contrast, experienced clinicians are often consulted by colleagues (within/outside their department) on unanticipated/emergent patient-related problems on days when they are already fully scheduled, so that they are forced to double book, and their TUR may exceed 100%. (Understandably, this “overbooking” must not affect care quality.) If this happens regularly, such providers may need additional help or incentives; alternatively, more providers may need to be hired.

In the example spreadsheet, practices A and B have high staff expenses with little revenue. RU review might suggest adjustments, including lay offs if needed.

INTEGRATED ANALYSIS, DECISION-MAKING, AND PLAN EXECUTION

The three elements enable leaders to create a composite picture of a realistic, viable action plan at both department and institution level (Fig. 4).

Department/Practice-level Steps

• a. Compare the annual budget target to actual performance. Variations provide useful information on the financial trend in both revenues/expenses and in terms of the equity and debt.
• b. Gather the financial, CP, and RU data for individual activities. Make allowance for shared resources because some divisions may share office space, nursing staff, etc.
• c. Ensure that activity-level data are accurate and dependable by sharing the data with the team. Reconcile discrepancies at this stage.
• d. Calculate metrics for profitability, liquidity, and performance, to cut costs, increase productivity collections, and provide a different direction to the practice. (eg, a predominantly reconstruction-heavy practice may gain revenue by adding a cosmetic line that generates better cash flow).
• e. Share perspectives for revenue/collection gains, cost reduction, and activity modification with faculty and staff. Their feedback and actionable recommendations help you make good business decisions with their buy-in.
• f. Implement the plan, specifying budget and timelines.
• g. Monitor performance continually against targets to validate/dismiss the action plan. Collaborative monitoring creates genuine partnership between faculty and staff.
• h. A portion of clinical profits can potentially be set aside to fund the academic mission. This requires a buy-in from the clinicians (who may receive a smaller bonus incentive), the health center leadership (that is willing to forgo a higher profit margin). It is doable, though not easy. Emphasizing the value of academic excellence (visibility, national ranking, and recruitment) helps make this proposition more convincing to the decision-makers.

Institutional-level Steps

Re-evaluate the value versus cost of each service and adjust the payor profile. It involves negotiation between administrators and physicians (hospital-side) and insurance payors. Steps include:

• Get support for cash-losing but valuable services, via reimbursem*nt renegotiations and/or alternative funding sources.
• Reallocate the most expensive service components to revenue-generating activities and delegating tasks by billable hourly rate.
• Share financial and clinical performance data with all stakeholders (clinicians included) to ensures better performance.
• Right-size cost allocation: Because direct costs are incurred (by clinical departments) and indirect costs are allocated (by the hospital), a department’s profits can drop if the allocated indirect costs are high. This raises several avenues for a measurement bias. Allocating indirect costs fairly and doing so with transparent negotiation with the department staff is essential to eliminate a disproportionate allocation, making departments unprofitable. Two methods followed are (1) sharing/collaborating with other departments to offset costs and (2) creating formulae for situations where an objective metric can be used for indirect cost-allocation (eg, maintenance and housekeeping costs can be calculated per square foot area of the clinic space). Even so, other costs, such as that of administrative services of the medical center, are harder to objectively quantify, and a fair transparent system helps maintain the bottom line.

CONCLUSIONS

Effective financial decision-making requires understanding financial metrics (which identify problems in general), and the domain (here, plastic surgery) to pinpoint specific causes of problems, to help devise appropriate solutions.

DISCLOSURE

The authors have no financial interest to declare in relation to the content of this article.

REFERENCES

Supplemental Digital Content

• PRSGO_1_1_2024_05_16_CHANDAWARKAR_GOX-D-24-00070_SDC1.xlsx; [Excel] (13 KB)