Make the connection between costs and profit

What you make depends on your practice’s costs

Neil Baum, MD, a solo practitioner and urologist in New Orleans, always thought he had a successful practice. He had patients who responded to his unique personalized style, and he has always operated on the belief that he has to take an active role in running his business. But until he did a cost analysis, Baum didn’t know how successful he was. And he was in danger of signing managed care contracts that didn’t give him an adequate profit margin.

"In an old fee-for-service practice, a doctor didn’t have to worry as much about business," says Baum. "But managed care requires more than just checkbook management. When you are at risk, you have to be involved, and you have to understand the cost of each service you provide before you sign a contract."

If, for example, you are offered 87 cents per member per month, that might sound good, he says, "until you discover that your costs are $1.07 per member per month." Knowing your costs can help you negotiate from a position of strength and know when to walk away from negotiations that aren’t going your way.

What you need

Baum says in order to do an effective cost analysis, you have to have a computerized office. He recommends two software programs: Contracts, made by Mainstreet Software of Sausalito, CA, and priced at about $1,200 and Capitation Calculator, which retails for about $2,000 from Provider Solutions in Kensington, MD.

A good office manager with experience in using a spreadsheet program such as Lotus 1-2-3 or Excel is also a must, Baum says, although for the first analysis you may want to hire an accountant with a background in medical practices who knows about CPT codes and RVUs.

You also need a copy of the appropriate Federal Register that includes updated RVU information. The RVU data is updated annually, and usually is included in the first Federal Register in December. Some of the software programs mentioned above may also have that data, he says, although it may not be as up-to-date as that in the Register.

Start with your utilization data. "You have to be able to estimate utilization based on sex and age for each service," Baum says. The Capitation Calculator has actuarial data on usage by region that may be useful for comparison purposes.

"You should find that 80% of your revenue comes from 20% of your services," Baum says. "You should do analyses of those services — usually no more than 20 to 30 items even in a busy primary care practice. There is no point in analyzing the costs of something you do only rarely."

Using a simple table and some simple equations (see chart p. 32), you can calculate your costs for each service, he says.

Start by putting down each CPT code and its frequency in the table. Find out the RVU for that code and multiply the frequency and RVU to get your total work for that service.

Then, write down the practice expense RVU, available from the Federal Register, and multiply that by the frequency of the code. Determine your malpractice RVU from the Federal Register, and multiply that by the frequency to get your malpractice RVU. The total cost for each service is the total of practice expense and malpractice expense.

If you want to figure your expenses without using the Register, Baum says that indirect costs — rent, malpractice, support staff salaries, benefits, and utilities — can be allocated evenly across the practice. "Just assume that indirect costs are shared equally by your services," he says. Your direct costs — the costs of the medical professionals involved in the service, as well as equipment and supplies used in its provisions — are added to the share of indirect costs to come up with a figure.

The problem with figuring it out yourself, Baum says, is the labor-intensive time and motion studies you will have to do to determine staff costs. For example, you will have to study each procedure and the time it takes to do it, then determine the salary and benefit costs of that staff time. "I don’t think the time is worth the effort," he says. "You are better off using the readily available data."

The whole process shouldn’t take more than 15 to 20 hours, or five hours for an accountant to do it. "If you hire an accountant, it shouldn’t cost more than $1,000," Baum says.

Reevaluating costs

Baum has undertaken the exercise just once in the last year. But when RVUs change, when a new RVU list comes out in the Federal Register, or when a new contract is negotiated, he says he will undertake the procedure again to ensure he knows his costs. He also recommends recalculating when you have a major change in your practice, such as taking on a new associate.

"Knowing the costs helps you ensure profitability, develop a budget, and set financial goals," Baum says. "You have an objective tool to investigate variance, and you are better positioned to thrive under risk sharing."

Understanding the relationship between expenses and revenues and linking each service with its financial impact is increasingly important in today’s health care market, Baum says. "Costs can be anticipated, monitored, and controlled to help your practice balance profit and quality."

Has it helped Baum? There are some concrete benefits he can point to. For example, one procedure he did in his office, urodynamic testing — a test done for treating incontinence — was expensive. The cost analysis showed that the cost of the disposable goods involved in the test was equal to the reimbursement the practice received from it. "We found ways to modify those costs," he says. "We found cheaper suppliers, a way to reuse electrodes after sterilizing them at the hospital, and smaller fluid bags." That total cost was cut by about one-third, making the procedures profitable for the practice.

There is also a more elusive benefit. "I know a range of payments I can accept now," he says. "I know I have walked away from contracts that I would have accepted before."