Importance of Costing Systems in Hospitals

Modern day hospitals provide a variety of services to patients under one roof. It is akin to a large service organization considering the number of personnel involved and the capital-intensive nature of the business be it the civil structures, operation theaters & equipment, diagnostic and therapeutic equipment, resuscitation equipment, gas lines, surgical instruments, consumables, etc. Moreover, it is a 24 x 7 operations with people playing a vital role in the well being of the patients in the hospital.

Unlike hotels or the hospitality industry, there are several distinguishing factors in a hospital such as:
  • It provides a fundamentally humanitarian service. Thus, hospitals cannot turn away needy patients just because they do not have money to pay or because it is a Medico-legal case. Hospitals have to factor in costs incurred during such a scenario in the financials.
  • Corporate hospitals have a profit motto. However, they also have a Corporate Social Responsibility in which they serve certain sections of the population, at no or little cost.
  • Other than corporate hospitals, we have either Government run or charitable trust run institutions. So, public funds which is involved needs to be efficiently deployed so that healthcare needs of a large mass of the population is met. This is true even if the objective of the institution is not to make profits.
  • Certain class of hospitals, which are predominantly trust run or enjoy municipal / Government benefits are supposed to reserve a proportion of beds for the economically weaker section and/or for patients below the poverty line. Hospitals have to create an Indigent Patient Fund to cater to these patients.
  • Services provided by hospitals are the same across classes of patients; however, hospitals tend to cross-subsidize general patients by charging higher to deluxe class patients.
  • Hospitals today service corporate as well as insurance / TPA patients. Because of the commitment to serve large number of beneficiaries, they tend to demand and get discounts on rack rates.
  • Pharmacy stores are also to be differentially charged to BPL patients compared to regular patients.
  • “Packages” also form a mainstay in the business especially in the cardiology, orthopedic, gynecology and obstetrics specialties as also routine daycare surgeries such as cataract, appendectomy, hydrocele, pilectomy, renal calculi or hernia.
  • Hospital Accreditation and quality standards ensure that hospitals follow documented policies and this helps hospitals in having predictability of outcomes.
The above complexities necessitates that the hospital management put in place robust costing systems. However, traditional hospital managements have not given serious thought to the same. The corporate world has adopted and benefited from good costing systems, since the early 1930’s. The same holds true of modern day corporate hospitals, who believe in providing cost effective services to patients and ensuring patient loyalty to the healthcare provider.

It is sad to see that in most hospitals, even today, the process of fixing the Schedule of Charges has no scientific basis. They simply survey nearby hospitals for their rates and fix their rates a tad above or below the other hospitals, depending on the Management Philosophy / Marketing Strategy.

Traditionally, hospitals used Bed Occupancy as the yardstick of measurement of performance. With the advancements in medical technology, the average length of stay (ALOS) is reducing and hence, bed occupancy is not the main performance measure any longer. The increased utilization of costly resources, e.g. equipment in operating theatres, ICUs, Cath-Lab, Pathology Lab etc. & Doctors’ times are the key to success in hospitals.

Importance of a good costing and management accounting system
The scenario in the past few years has changed dramatically within the healthcare industry. Established names in the industry are facing tremendous competition from the newcomers. Thus, each hospital has to be competitive both in terms of the quality of services as well as cost management.

Until a few years ago, it was practically absurd to think of a Marketing function within a hospital. That situation is passé with almost every hospital worth its salt employing marketing professionals to attract new corporates. Hospitals also employ Loyalty Cards, Discount Health cards to attract and retain customers.

The advent of health insurance companies has also queered the pitch. With the costs of treatment going up and the privatization of the insurance industry, the hospitals are forced to give quality service at highly competitive prices as the insurance companies will pay only for the services that are desired and will also monitor the services that are rendered closely. This leads to deductibles, co-payments and all claims by hospitals do not get settled hundred per cent. There is also a time element involved as costs are incurred upfront and outstanding amount is received only after a couple of months.

It is therefore imperative for hospitals to have a system to control the costs, while at the same time providing high quality service to the patients.

The Costing Problem
Patients undergoing treatment receive services of varied nature from different departments. The hospital has to recover the expenses of the direct departments as also of the support departments from the patients availing of these services.

Nowadays, any composite hospital with latest facilities for advanced medical/surgical procedures in the various areas of treatment will have nearly 50 or more revenue centers and about 10 to 15 supporting service centers. Furthermore, most of the revenue centers, particularly, in-patient wards, will have classification depending on the level of services for different class of patients according to their monetary or other needs. Again, each department, other than Wards, undertakes several types of procedures/operations etc.

All these make the list of procedures and classification of services quite large. It is for this reason that ascertaining true costs of various services and fixing of the Schedule of Charges becomes extremely complex. Costing needs to be done after careful analysis of past data, comparative data from other hospitals, study of utilization of capacities. Costing techniques shall be applied to provide acceptable costs and charges, enabling optimization of capacity utilization, which, in turn, result in better overall revenues and leave adequate funds for growth and development of newer and advanced facilities.

Setting up a Costing System
Unlike in other industries, where pricing of products / services is generally uniform except in special cases such as exports, institutional sales etc., in hospitals most of the services rendered are charged at different rates based on class of patients. Besides, a category of patients are given free or semi-free treatment, where the charges are nil or kept very low.

Thus, the final charges or pricing has no direct relevance to ‘costs’ individually. But, the overall revenue expected from the charges recovered from all patients has to cover the total costs incurred, to make the procedure or department self-supporting. This matching of expected revenue and costs can be done only on the basis of exhaustive analysis of past quantitative and financial data. Thus, detailed statistics play an extremely important role in Costing of services and fixing of schedule of charges.

Based on such analysis, discussions with medical personnel of each department, regarding the practical problems and expected quantum of each procedure withclass-wise level of patients and detailed budgeting of revenue has to be made. This forms the broad structure for cost allocation to the various cost centers and fixation of individual charges. Keeping in mind the purpose and its importance to the hospital in recovering all expenses incurred, the procedure for cost allocation should be designed so as to obtain accurate and realistic results. We shall not go into the intricacies of these procedures in this article but limit ourselves to the basic steps for the purpose of ascertaining the final costs to obtain the desired results.

Broadly, the steps needed are:
  1. Identify the various cost centers in the Institution and arrange them into:
    1. Revenue producing centers by charging to patients for the services and
    2. Supporting non-revenue producing centers
  2. Allocate direct expenses to all centers by analysis of each element of cost
  3. Develop cost allocation criteria for allocating costs of supporting cost centers to other supporting cost centers and revenue producing centers, ultimately bringing all costs into revenue producing centers, do this on the basis of services rendered for other centers.
  4. Now, each revenue center has the total direct costs of the center and indirect costs representing the allocated expenses of the supporting centers.
  5. The total costs thus arrived at for each of the revenue providing centers is to be appropriately distributed among the various services rendered to the patients by that center. This involves not only finding the nature of the services but also learning the general application of the services to the patients. This should be done in conjunction with the medical personnel and modalities determined for each type of service.
Once the costs are available for each profit & cost center, they can be used for the various purposes identified earlier. Typically, to arrive at the above costs, one needs to setup various monitors across the hospital, which will give the necessary data for computing the costs. Computerization could significantly simplify the process of data collection and analysis. A good Hospital Management System software should form the basis for the costing system.

Objectives of a costing system

Utilization of resources:
A costing system should monitor the resource utilization across the hospital. These resources can be infrastructure, equipment, materials or personnel. Each department has a key driver and the system should track these drivers on a continuous basis. This will ensure that each department is efficient.

Department-wise profitability analysis
A good costing system should enable generation of this very valuable information on an on-going basis. Managements can take corrective steps using this data. It enables fixation of responsibilities and monitoring them. Coupled with a budgeting system, hospital management will have full control over the working of the hospital.

Fixation of doctors’ honorarium
This is a very touchy subject for most hospital management. The honorarium systems can be very complex, with some hospitals adopting honorarium calculations, for each individual consultant. With a costing system, they can negotiate a fair rate for the doctors for each service rendered. The doctors also will be assured of a reasonable and scientific basis for their remuneration.

Fixing Schedule of Charges
This document also called the Rate card can make or break a hospital. The costing system should provide inputs to fix the charges for the various services rendered for each class of patient.
For purchases of new equipment or infrastructure, the costing system should enable the managements to arrive at the feasibility of the project, based on hard data. More importantly, the system should keep track of the status of the projects after they are commissioned. Generally, at the time of feasibility stage, certain estimates & assumptions are made. But almost never are they monitored after commissioning.

Monitoring of factors affecting pricing
The costing system will keep a tab on all factors affecting pricing. For example, material costs directly affect prices. Any major variation in material costs should be highlighted and price changes effected immediately after ascertaining the impact of the variation on margins.

Whatever be the philosophy of the Management, they need to ensure efficient utilization of costly resources and they should take informed decisions on pricing. A scientific Costing system is a very important tool for Managements to fulfill these needs and hence, is imperative for the successful running of a Hospital.

About the Author:

Mr Ravi Mani is the CEO of 21st Century Health Management Solutions and has over two decades of experience in designing robust solutions in the Healthcare vertical. Mr Ravi Mani has a Bachelor’s degree in Engineering and is a qualified Cost Accountant.


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