Case Costing in the Surgery Center:

By Donna Boyle

How much does it cost your facility to perform a surgical case? Does that question cause you to hesitate?

Although the answer seems easy, we are often unsure of our response, and feel that no matter what the answer is, we first need to qualify the meaning.

The traditional way to find your average expense per case would be to divide your total expenses on your income statement by the number of cases. Using a reasonable time period, this method gives you a pretty accurate average of what you spent per case. And averages are good. Cost accounting is not a precise science. It’s based on averages, allocations and “best guesses.”

This method, however, presents two problems.

First, it counts simply what you spent during the time period of the cases. Consider the definition of expense: the cost of goods and services used up in the process of obtaining revenue.1 It is possible that not everything that was expensed was consumed. More importantly, however, it doesn’t really help you understand the nature of your costs. How can you improve your performance with such generalized information?

Detailed cost information provides you with the tools to effectively conduct payor negotiations, engage in strategic business planning and review your clinical pathways. It helps you make decisions such as whether to expand the facility in order to accommodate new specialties, to close an operating room or to hire more staff. It also helps you determine where your operation may be slack, including poorly controlled inventory or under-utilized labor. Clearly, management decisions made without sound data - decisions based on a hunch or “I think” - are more likely to yield failure than success.

Of course, although case costing is important, it must also be kept in perspective. You will never know to the penny the exact cost of any given case. There are always unpredictable events, most of which are too inconsequential to measure. Perhaps it was a particularly cold day and your furnace ran like crazy. Maybe the patient needed to clarify a lot of demographic information, so the intake process was prolonged. That being said, the inherent problems in calculating cost do not justify avoiding it.

Fortunately, computer software is now available to assist surgery centers with accurate cost analysis. It may even be embedded in your facility’s Management Information System (MIS). Although not necessary, this setup is ideal because it can allocate costs to specific cases and analyze data by case type or procedure. But to use it correctly and get reliable results, you must understand the basic principles of cost analysis. Even the most sophisticated software requires the user to identify both the cost elements and how to measure them.

Knowing your cost elements can also guide your data collection. Your MIS may provide components that you fail to utilize because you never realized their importance.

Some systems can collect detailed time information for each case, from pre-op to PACU to individual staff utilization.

Unfortunately, facilities may not bother to collect the data because they don’t recognize the benefits.

The most appropriate costing method for a surgery center is Activity Based Costing (ABC). This method examines each activity necessary to complete the surgery event. It originated in the early 1980s to facilitate product cost management in manufacturing.

However, it has expanded to other industries as well. In the words of its developer, Dr. Robert S. Kaplan, “ABC reveals the links between performing particular activities and the demands those activities make on the organization’s resources.”2

Absorption and direct costing can both be used with ABC. Absorption costing includes fixed overhead as part of the product cost. It is preferred in a surgery center because revenue from the product must cover all costs, direct and indirect, fixed and variable.

If you identify each activity and the resources it requires, you will know your business practices very well. This knowledge gives you the power to effect positive changes.

We will consider five aspects of cost accounting:

1. Cost Allocation. All cost-accounting methods use observation and allocation.

Allocation simply means to distribute or apportion. After identifying activities, you use two determinants to allocate facility costs to surgery cases: direct/indirect and time or case basis. From your utilization studies, you can determine whether activities involve the surgery event directly or indirectly, and if the activity is influenced by the amount of surgery time. For example, scrub nurse cost would be direct (specific to that case) and allocated by time, because the amount of time in the OR influenced that particular labor cost. On the other hand, the cost of the medical chart would be indirect (used by all cases) and allocated by case, since all cases use roughly the same amount of materials. Facility overhead could be allocated by surgery time, because items such as rent and insurance are time-based.

2. Cost Elements. In a surgery center, there are four basic elements of cost. In simple terms they are:

• People to do the work (labor, often divided into clinical and non-clinical) • Items for the surgery (supplies, services and equipment)
• Items to run the facility (supplies, services and equipment)
• The facility itself (overhead) Within these broad categories lie myriad details. It is up to you to organize the details into manageable divisions. Develop a short list of activity types. A quick glance at your income statement will reveal one or two categories that constitute the lion’s share of your expenses.

Concentrate on them; that’s where most of your money goes. Although you may not agree with all of them, the following examples of sub-categories reflect the ABC approach.

Labor. The traditional clinical vs. nonclinical split isn’t necessary, but it helps discover if you have highly paid licensed people doing activities for which less costly employees may qualify.

• Direct patient care (surgery, pre-op, recovery)
• Clinical support (pick cases, chart, stock, outfit and clean rooms)
• Paid breaks (scheduled breaks, down time between cases)
• Other (complete time sheets and reports, prepare staff schedule, meetings, training)
• Benefits (payroll taxes, unemployment and health insurance, pension, PTO) Non-Clinical:
• Patient-related clerical (admitting, medical records) • Finance-related clerical (billing, collections, posting) • Other (complete time sheets and reports, meetings, training, banking, mail) • Paid breaks • Benefits (payroll taxes, unemployment and health insurance, pension, PTO)

Items for Surgery. Apply the same idea to the supplies and services used in surgery.

Supplies (surgical, anesthesia, other drugs, recovery, disposable garments and bedding) Services (equipment rental, pharmacy)

Items to Run the Facility. Categorize the supplies and services used in admitting, billing, registration and physician relations.

• Paper (claim forms, patient charts, forms and labels) • Services (transcription, housekeeping, equipment rental)
• Communication (telephone, answering services, postage and courier services)
• Legal (business taxes, license fees, dues and subscriptions)

The Facility. Group all of your overhead cost elements.

• Site (facility rent, utilities, property taxes)
• Protection (liability and hazard insurance)
• Maintenance (grounds, security)
• Depreciation (plant and equipment)
• Amortization (leasehold, intangibles)

3. Inventory Control
The best way to manage supplies is by a perpetual inventory system. Of course, you might wonder, who has time for that?

“Although the perpetual system is more costly than the periodic system to implement, it facilitates better inventory planning and control.

In the past, perpetual records were used primarily for low-volume, high-cost items ...with computers, companies can conveniently store and retrieve large amounts of data in a cost-effective manner.”3 Managing a computerized perpetual system is more efficient than dealing with information spread around on pick lists, preference cards, order cards, paper POs and receiving documents.

Surgery center management information systems usually come complete with inventory modules. Most provide some type of preference card to manage the supplies used in each case, both to prepare the room and to record usage. Under a perpetual inventory system, all supplies purchased are recorded in the general ledger to the inventory asset account(s), and inventory reports of supplies used provide the expense to be recorded in the general ledger. In that way, the supply expense always matches the cost of supplies actually used to generate the case revenue. Periodic physical counts reveal unrecorded inventory loss or overage.

Even if you do not use perpetual inventory, you should still perform periodic spot checks.

Don’t forget depreciation expense. How much does the obsolete equipment in storage cost you? And what about that broken desk copier in the back closet? Asset management is as important as inventory management.

4. Utilization Studies

Knowing the categories of expense does not automatically provide you with useful data. Your payroll records may distinguish sick and vacation leave, but they do not reflect paid breaks such as time spent on morning and afternoon breaks, waiting for a case to start, changing clothes, etc. Nor will your inventory system automatically distinguish items taken from inventory from those used in cases. You will need to perform some studies on the ground.

Ask yourself, “What is everybody doing?”

Follow your staff around for a while. Using your cost categories, track their time (and modify your categories as needed). You may find unidentified and unproductive paid time.

This provides you with two pieces of information.

First, if your staff spends x doing cases, you must add y percent to cover these elusive activities. Secondly, you may find the cause of down time: perhaps inefficiency is built into the placement of supplies or documents, facility geography or the staff schedule itself.

Next, examine your inventory. See what items left the stock room but were not used in cases. They may be lost because they are out of date, spoiled, misplaced, or stolen. You can then determine a rough percentage of clinical supply cost that is not used in cases. Using the Absorption Principle, these costs belong to the cases performed because their revenue must cover those as well as the direct costs.

5. General Ledger Design
If your general ledger chart of accounts matches your costing model, cost is readily known. Each cost element and sub-category should have its own ledger account.

Additionally, a separate account should be created for each sub-category according to whether it is allocated by time or by case, directly or indirectly. Then your expense information is organized and ready to plug into your management information system.

Even if your MIS does not have a cost analyzer, you can enter the information straight from your general ledger into a spreadsheet.

Knowing which items are direct and indirect, allocated per case or per time, it is easy to develop your average cost per case.

Manually calculating cost per case by specialty or procedure is much more difficult. To determine that cost, you need to know which items of labor, supply and service expense, and equipment depreciation belong to individual cases.

Assuming you scrupulously enter the data, your MIS can provide that information, but to process it manually would be very time consuming.

Although the costing process can be labor intensive at first, once the initial legwork is complete, you can set systems in place to capture the necessary information on a routine basis. You will then have vastly improved the tools that you need to manage your facility, to discover leaks in your expense network and to make sound business decisions.

Donna Boyle is a senior business analyst for surgical solutions at Source Medical, the leading provider of outpatient information management solutions, with products installed in more than 3,500 facilities nationwide. Boyle can be reached at (800) 719-1904 or via e-mail at: donna.boyle@sourcemed.net.