All things budgets

Episode 3: All Things Budgets

So, what’s all this hullabaloo about budgets? And why would you want one? Consider that a budget is like your financial GPS. By utilizing one, you can determine where you’d like to go financially, and then you can assess your progress against that plan.

I work with a lot of small and mid-sized practices that operate without a budget. It is possible to do, and some groups just compare their financial performance to last year or the last year to date. This can be an effective way to start if you don’t use any measuring tool at all, since it doesn’t require any preparation.

When I prepare a budget, I am looking at the Profit & Loss, or the Income Statement. As we’ve been discussing, this report shows financial activity over a certain time period, most commonly a month. It shows the inflows of money (typically called Revenue), and it shows the outflows of money (e.g., Expenses). When you subtract the Expenses from the Revenue, that is typically called Net Income, and it’s the amount of money that you and your partners get to split up and take home if you’re in a private practice.

I begin my budgeting process by seeing how the clinic performed in the same time period in the prior year. As much as we may not think so, medicine is a seasonal business:

1. First, we deal with flu season in the Winter,
2. Then deductible season in the Spring,
3. Then I’m-not-going-to-the-doctor-because-it’s-Summer season,
4. And finally, we end the year with I-HAVE-to-get-in-because-I-already-met-my-calendar-year-deductible season.

Each of these seasons has an impact on the financial health and the ebbs and flows of money through your practice. If we begin the budgeting process with a look back at last year’s performance, this is very instructive. Then you’ll get to think through what may have changed, or if there were any unusual events that won’t reoccur. A pandemic is an excellent example. A new physician starting in your practice or the departure of a physician from your practice are also examples of events that will have a significant impact on your financial performance and should be considered in your budgeting process.

Now, as I begin writing a budget, I always aim to have a conservative budget, so that when you outperform it, everyone is pleasantly surprised! ​By conservative budgeting, I mean estimate low on revenue and add in all the expenses you think are reasonable. This gives you the best chance of leaving everyone pleasantly surprised. Be sure you don’t go too conservative; however, you might scare everyone when you present the budget if it looks too dire!

As we’ve said, the historical perspective is always instructive, and once you’re clear in your review about what happened last year and how it will impact your budget, you can begin looking forward. I typically take last year’s total performance and divide it by 12 to create a monthly budget. Then I can make appropriate seasonal adjustments for months with 3 payrolls (if your payroll is paid bi-weekly instead of semi-monthly). I also adjust for Medical Malpractice premiums, which are frequently paid quarterly. I then add in quarterly and annual expenses like tax preparation, quarterly tax payments, legal expenses​, and contributions to 401(k) or profit-sharing plans.

If your budgeting is a bit more sophisticated, you might consider building a dynamic budget utilizing patient volumes​, so that you can adjust for those and create some different scenarios if your practice is in a space of growth. More on that in our eLearning Series.

With any medical group’s budget, the two largest costs will typically be staff salaries and rent expense.​

As we’ve discussed earlier, with the split between fixed and variable costs, I generally recommend that groups consider staff salary expense as 50% fixed and 50% variable. Why? Because you need a certain number of staff to open the doors and answer the phones, and there are more staff that are needed as your patient volumes increase. I have found this a fairly straightforward way to allocate those big costs inside of groups for whom it is important.

Over the past many years, I’ve used a traditional inflationary factor of 3% year over year, which means when I create a budget, I have historically increased most expenses by 3% to account for inflation. As our economy takes us on this wild ride, we have to ask ourselves: what is it now?​

I have seen medical groups giving much larger increases in staff salaries when it comes time for raises. Our clients have been giving pay raises of 5% – 27%. Think about what your group has been doing, and is likely to do in the upcoming year. Staff retention is so important, and competitive compensation is key to that.

Rent increases will be dictated by your lease, so it’s important to know when budgeting the date that your lease will renew. Most leases have an annual escalator built in, so you can check for that language. Again, in the past, it’s been somewhere around 3% per year, but we’re likely to see higher increases in the upcoming years. Be prepared if your lease renews any time in the next couple of years.

Now that you’ve gotten the historical monthly amounts, and you’ve made adjustments for big changes, and smaller adjustments for unusual items and inflation, now it’s time to check out the bottom line, and have a bit of a “reality check.”

Some key questions I ask myself at this point:

 

• How does my budget compare with last year’s actual performance?​
• How does the bottom-line look?​
• Will physician incomes go up or down?​
• Have I prepared them for that?​

Again, as we’ve said, introducing a conservative budget that you expect to outperform is great, but there’s a balance to be struck so that it doesn’t look too “doom and gloom” to begin with.

Now that you’ve created a budget, how do you use it? The Budget to Actual analysis is the most important part of the exercise. We recommend that all groups review their Profit & Loss in a Budget to Actual format each month. This should include five columns:

1. Budgeted Performance
2. Actual Performance
3. Dollar Amount of Variance from Budget – positive or negative – negative frequently shown in parentheses and / or in red
4. Percentage Amount of Variance from Budget – again, positive or negative – negative frequently shown in parentheses and/or in red
5. Notes section – here is where you should expect to see a note about any major variances from the budget.
6. Why is it important to look at BOTH a dollar amount variance and a percentage variance? Because you may have the same dollar amount variance on two different lines of your budget, but one may be a much larger percentage, and therefore more concerning. If you have a $50,000 budget variance on a line where the original amount was $60,000, you’d be much more concerned than if you had that same $50,000 budget variance on a line where the original amount was $5,000,000. Budget analysis should always include the definition of your group’s variance limits. As you get familiar with your financial performance, you’ll understand better what amounts you want further analysis on. In short, you’ll figure out how much you care about a variance. Many groups will say the variance has to be more than 5% and more than $X before they want to see a comment.

If you do have a budget line item with a variance that exceeds BOTH thresholds, you (or your finance person) should anticipate a question about that, and answer it in the Notes section in that 5^th column. That way, all partners and stakeholders can easily and quickly review the Budget to Actual and the majority of their questions will be answered.

A note of caution about comparing yourself to another clinic – we’ll do a deeper dive on benchmarking in upcoming episodes, but for now, my caution is that comparing your medical group to another is much like comparing apples and oranges. Or, even kumquats! I know it’s fun to see how you measure up, and every clinic is unique, so compare with care!

That’s what we have about budgets today – I hope you’ll join me for our next episode, where I get to spend time with Kem Tolliver and Shawntea Gordon. These ladies literally wrote the book on Revenue Cycle, as published by the Medical Group Management Association, and I can’t wait to unpack that with them – and you!

As I’ve said many times, this podcast series is intended a gift back to a community that has been good to me for 30 years. Remember, this podcast is for you. My goal is to give you bite-sized, digestible pieces of knowledge culled from the last 30 years spent working in the business of medicine. My commitment is to bring you resources, experts, and answers so that you can achieve mastery over the financial and business aspects of your practice. Together, we can fill in that educational gap.