Healthcare Finance: Cost Analysis and Inventory Presentation

This presentation provides a detailed overview of healthcare finance, covering key concepts from chapters 6, 7, and 8 of the textbook "Healthcare Finance" by Judith F. Baker and R.W. Baker, along with an analysis of an article by Shepard, Hodgkin, and Anthony. Chapter 6 delves into cost classifications, differentiating between direct and indirect costs, as well as product and period costs. Chapter 7 explores cost behavior, including fixed, variable, and semivariable costs, and introduces break-even analysis. Chapter 8 focuses on inventory management, including FIFO and LIFO methods, and depreciation concepts, covering various depreciation methods. The presentation emphasizes the importance of financial knowledge for healthcare practitioners to make informed financial decisions and manage costs effectively. The article provides a managerial perspective on hospital cost analysis.

Healthcare Finance
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Introduction
In the medical field, there are different critical financial decisions which are supposed to be
made by the medical practitioners working in the field for proper management of the funds in the
field. This means that the medical practitioners need to have some basic financial knowledge and
skills which can help them to manage the funds in the medical field appropriately. This will help
them to avoid incurring some unnecessary costs or some avoidable expense which end up causing
great losses to the medical organizations. This presentation aims to discuss different financial
concepts encountered in the medical field as discussed in chapters 6, 7, and 8 of the book
“Healthcare Finance” written by Judith F. Baker and R.W. Baker.

Chapter 6: Cost Classifications
This chapter mainly discusses different types of costs incurred in healthcare
organizations. The chapter classifies the costs into different categories depending on how
they are spent in healthcare organizations. This classification is very important as it helps
the readers of the chapter to understand different types of costs and how they are
applicable in healthcare organizations, and so, when working in the medical field, the
readers will be in a better position to understand and control different types of costs which
they may be required to spend in various projects.

Firstly, the costs can be classified as indirect costs or direct costs. Direct costs can
be described as the costs which are associated with a specific or a particular unit,
department, or patient. These costs are normally associated directly to the cost object(s)
involved in the spending of the costs. Direct costs include managed care marketing
expenses, clinic telephone expenses, emergency room medical supplies expenses, among
other expenses (costs). Unlike the direct costs, indirect costs are the costs which can’t be
attributed to any particular or specific unit, department, or patient. Indirect costs include
real estate taxes, liability insurance expenses, utilities for different medical facilities
expenses, among other expenses or costs (Baker & Baker, 2015).

Direct costs are normally meant to benefit a particular department (unit) and can easily
be traced while the indirect costs are usually meant to benefit the whole operation
(organization) and not any particular unit. These costs have to be fairly allocated to different
units. These two types of costs can be represented by the diagram shown below:

The other main classification of costs is where the costs are classified as period costs and
product costs. The product costs are the costs attached to products after the manufacturing
process and the products are placed into an inventory as they wait to be sold. After the selling of
the products, they are normally removed from the inventory list, matched with the revenue
generated, and then recognized as some special costs referred to as the product costs. Unlike the
product costs, period costs are normally not associated or connected to the manufacturing
process. The costs are normally matched with the revenue based on the period when the costs are
incurred, and that’s the main reason why they are known as period costs (Baker & Baker, 2015).

Chapter 7: Cost Behavior and Break-Even Analysis
This chapter discusses different types of costs, the cost behavior, and covers the basics of
break-even analysis. It’s important for healthcare professionals to understand different types of
costs and cost behaviors as this knowledge is an important tool required in achieving effective and
efficient financial management in the medical field. The main types of costs incurred in healthcare
organizations are the variable costs, fixed costs, and semivariable costs. To start with fixed costs,
they can be defined as the costs which don’t vary in total when the volumes or activity levels of
operations vary (change). Variable costs can be described as the costs which vary in direct
proportion with the variation of activity levels or volumes as operations change. Semivariable
costs are the costs which vary when the activity levels of volumes of operations change, but their
variation is normally not in direct proportion with that of the activity levels (volumes). The most
common variation pattern in semivariable costs is the step pattern (Baker & Baker, 2015).

Mixed costs are costs contain two or more of the types of costs discussed above. Mixed
costs are very common in organizations, and so, it’s highly recommended that all managers
should understand them and know how to analyze them. There are two simple methods which
are used to analyze mixed costs. These methods are the step method and the predominant
characteristics method. In the predominant characteristics method, the managers normally
judge whether the cost is more of variable or fixed cost while in the step method, the managers
normally examine the steps which occur in the step pattern and decide whether the patterns
appear to be more variable or fixed. These two methods are just judgmental and entirely
depend on the managers’ judgments or decisions (Baker & Baker, 2015).

Contribution margin is another important aspect related to costs behaviors and can be
described as the margin or the difference between the variable cost and the net values. It’s
normally computed or calculated by deducting the variable cost from the net values.
Contribution margin normally contributes to fixed costs and profits. The breakeven point
also referred to as the cost-volume-profit (CVP) is another important term encountered
when studying costs and cost behaviors. The breakeven point is the common point where
the contribution margin is normally equal to the fixed costs. At this point, point loss equals
loss, more equals profit, and thus, a breakeven point (Baker & Baker, 2015). A CVP chart
for a Wellness Clinic shown below can be used to illustrate this:

Chapter 8: Understanding Inventory & Depreciation Concepts
Inventory and depreciation are very important financial concepts which should be clearly
understood by the healthcare managers and other healthcare practitioners for them to manage
their finances appropriately. Inventory can be described as a detailed list which contains all the
items (goods) which organizations intend to sell in the course of their operations. Depreciation
can be described as the reduction of value of goods (commodities) which occur with time due
to different factors such as wear and tear, varying market conditions, among other factors (Del
Giudice, Manganelli, & De Paola, 2016). When intending to sell different goods, organizations
must always be keen to sell the goods as fast as possible to avoid facing heavy depreciation
losses.

To start with inventory, as already stated above, it’s a list which contains the goods
which organizations intend to sell in the course of its operations, and these goods are
normally placed as current assets in the balance sheets. In most cases, the goods listed in
the inventory are normally expected to be sold out within the 12-months period of
operation. When a good listed in the inventory is sold, it’s normally moved from the
inventory in the company’s balance sheet to ‘cost of goods sold’ in company’s income
statement. The whole process of recording inventories in the accounting cycle can be
represented by the diagram below:

There are different inventory methods which are used in valuing of inventories. The
most common methods are first-in-first-out (FIFO) and the last-in last-out (LIFO) method. The
FIFO method normally recognize the first costs in the inventory as the very first costs to be
moved out to the costs of goods/products when a sale is made. This means that if costs have
gone up in a particular year, under FIFO method, the ending inventory will be definitely
higher since the oldest less costly (cheaper) inventory goods already moved out first. Unlike
FIFO, the LIFO method normally recognize the last or the latest costs placed in the inventory
as the first costs to be moved out into the cost of goods if a sale is made. This means that if the
costs have gone up (risen) in a year, under LIFO method, the ending inventory will definitely
be lower since the latest more costly goods were moved out first leaving the older less costly
goods in the inventory. Other less common inventory methods include the weighted average
inventory method and no method inventory method (Baker & Baker, 2015).

Depreciation concept is another important financial concept applicable to
healthcare organizations. The useful life of fixed assets determined the period over which
the cost of the assets will be spread. The salvage value also referred to as the scrap value
usually represents any unexpected cash value of an asset at the very end of the asset’s
useful life. The rest of the salvage value doesn’t depreciate since it’s expected that it will
be recovered. The annual depreciation expenses are usually recorded at the income
statement and the same amount is normally added to the accumulative amount column of
the balance sheet in the Reserve for Depreciation.

The net book value also referred to as the book value of fixed assets is the balance
sheet figure which represents the undepreciated portion/part of fixed asset cost. There are
five main methods which are used in the computation of book depreciation. These
methods are the straight-line depreciation method, the double-declining-balance (DDB)
method or the 150% declining balance (150% DB) method, the accelerated book
depreciation method, the sum-of-the-years-digits (SYD) method, and the units of service
or the units of production (UOP) method (Baker & Baker, 2015). The choice of the
method to use entirely depends on the person analyzing the depreciation and the nature of
data whose depreciation is to be analyzed (calculated).

Article – Analysis of hospital costs: A manual for managers by Donald S. Shepard,
Dominic Hodgkin, and Yvonne E. Anthony
This article discusses some of the main costs which are incurred in the medical
field. The article clearly explains that the managers working in the healthcare field must
always be very careful in the way they spend their funds to avoid incurring some
unnecessary costs which may end up landing their organizations in financial crises. From the
article, we learn that the healthcare managers working in both the private and the public
sectors including in the profit and the non-for profit medical organizations face a serious
challenge in managing their finances as some of them end up incurring some unnecessary
costs which land their organizations in financial problems.

The article is prepared with the intention of helping the managers working in
the medical field at different levels to understand how cost analysis can help them to
make effective financial decisions for their organizations. The article is also meant to
help the managers to define and institutionalize the relevant costing systems which
can help their medical organizations. The article is hoped to help in improving the
overall financial management strategies employed in the medical field by reducing
the unnecessary costs incurred in the medical field, and this will consequently
improve the overall performance of the medical field (Shepard, Hodgkin, & Anthony,
2000).

Conclusion
To conclude the presentation, we can say that financial knowledge is very important
in the medical field where it equips the medical practitioners with some important skills
which they require to make some critical financial decisions which are required in the
medical field. Therefore, all the medical practitioners should always strive to have some
basic financial knowledge and skills which will enable them to solve some financial
challenges such as incurring some unnecessary costs which end up landing the medical
organizations in great trouble. This way, the financial and the overall performance of the
medical field will be greatly improved.

References
Baker, J.J., & Baker, R.W. (2015). Healthcare Finance. Massachusetts: Jones and Bartlett
Learning, LLC.
Del Giudice, V., Manganelli, B., & De Paola, P. (2016, July). Depreciation methods for
firm’s assets. In International Conference on Computational Science and Its
Applications (pp. 214-227). Springer, Cham.
Shepard, D.S., Hodgkin, D., & Anthony, Y.E. (2000). Analysis of hospital costs: a manual
for managers. Geneva: World Health Organization.