In an ever-changing health
care environment, the accuracy and effectiveness of financial forecasts have
faced increased scrutiny and inquiry from health care entity boards and
management teams.
As a result, BKD
has developed a 3-part series to address the most common mistakes we see in
financial forecasts prepared by health care entities.
In Part II,
we examine common mistakes related to maintaining consistency among forecast
assumptions. Part I addressed mistakes related to the effect of complacency on
the forecasting process, while Part III will cover aligning the forecast with
the entity’s overall strategic mission.
For many health care
entities, the budgeting and forecasting process is completed over several
months as the management team gathers input from department heads and other
parties. Throughout this arduous process, it is easy to get lost in the details
and forget the big picture.
Furthermore, department heads may provide input
without knowledge of all other assumptions, leading to a final forecast that
includes assumptions inconsistent with one another.
Specifically, consider the
following common forecast oversights:
Lack of a Market
Assessment
In addition to simply analyzing historical volume trends for the
entity, management should complete an overall market assessment of the service
area. Knowing the service area’s demographic trends can help management
determine volume forecasts.
For instance, many rural hospitals face decreasing
populations and declining inpatient use rates. To keep patient volumes steady in
this scenario, the entity would need to increase its market share.
However, the
opposite also is true, as an increasing population may help an entity sustain
increasing volume levels without increasing market share.
Disconnecting Revenues and Expenses
Once the market assessment and
volume/revenue forecast are completed, management should ensure the expenses
necessary to support any changes in revenues are included in the forecast.
Staffing costs typically are the largest cost incurred by a health care entity,
and these costs should be evaluated in comparison to expected revenue changes.
Management can evaluate trends in ratios compared to industry benchmark amounts,
including salaries and wages as a percentage of net patient service revenue and
full-time equivalent employees per adjusted occupied bed.
In addition, analyzing
the fixed and variable portions of expenses becomes essential as volume changes
are implemented into a forecast.
Ignoring Debt Covenants
Management should ensure required debt covenant calculations, such as debt
service coverage or days cash on hand, are incorporated into the forecast.
In
addition to knowing the minimum levels required, management also should
incorporate a higher “target” level for any debt covenants to allow for a safety
cushion. If the forecasted results approximate the required covenant level, an
unexpected event -- even if relatively small -- could send management reeling for a
response.
Ignoring Cash Flow Budgets
Often, management
teams fall into a trap of preparing a forecast to address the statement of
operations, but ignoring the statement of cash flows.
Although preparing a
full statement of cash flows is more cumbersome, “cash is king,” and it should
never be ignored when preparing a forecast. Balance sheet items could have a
large effect on cash flows, such as debt service requirements (including
required reserve funds), capital expenditures, pension requirements and working
capital changes, among others.
In addition, for capital projects that include
additional debt, it is imperative to evaluate the useful life of the asset
driving Medicare reimbursement compared to the term of the related debt, as the
entity may end up in a situation in which it will be making debt payments in the
future with no associated Medicare reimbursement.
In
summary, management should consider how its forecast compares to the trend in
recent historical years. Management should be able to qualitatively and
quantitatively summarize the key factors causing any major fluctuations and
should consider implementing a “1-time items” summary to disclose to users of
the forecast how significant nonrecurring transactions affect year-to-year
trends.
While avoiding the mistakes discussed above can help
improve the forecasting process, these represent only a sliver of potential
oversights management teams make in the forecasting process. Refer to Part I,
discussing the effect of complacency on the forecasting process, and look for
Part III, discussing the alignment of the forecast with then entity’s overall
strategic mission.
The full version of this article appears on BKD. This version is used here with permission.
