Learn the ABCs of activity-based costing

Follow these steps to lift the bottom line

It’s not good enough to simply want to cut waste out of your business; it’s a necessity. To get the biggest bang for the reimbursement dollar, home infusion providers — like the rest of the health care industry — are being forced to operate with minimal costs without adversely affecting patient care. Tom Pryor, president of ICMS (Integrated Cost Management Systems), a health care consulting firm in Arlington, TX, says there’s a way to streamline your costs using activity-based costing (ABC) and activity-based management (ABM).

"Activity-based costing and management is simply looking at the labor and overhead of an organization by activity instead of by type of resource, salaries, fringe benefits, travel, etc.," says Pryor. ABM focuses on measuring work, while traditional accounting focuses on measuring workers. Here are the basic steps required in doing an activity-based costing analysis of your operations.

1. Spread it out.

"The basic format we use is a spreadsheet with columns and rows," says Pryor. "First, we define the significant activities of a group of employees and place these activities at the top of each column."

He notes that "significant activities" are those that consume more than 5% of an employee’s time or resources.

Each row of the spreadsheet is then allotted a resource needed to perform an activity, measured in dollars, such as salaries, fringe benefits, supplies, telephones, computers, etc.

2. Fill it in.

"At the bottom of the spreadsheet, after you determine how much resource is consumed by each activity, you measure the output and what is the workload of each activity," notes Pryor.

To fill out the activity accounting spreadsheet, ask employees, "How much time do you spend performing your activities?" Pryor recommends you have employees estimate their time in 5% increments. The same method is used for all the other resources.

To complete such a chart takes approximately 90 days, according to Pryor. The key is to use a representative sample to avoid measuring costs during a peak or valley of expenditures.

"For a pilot project, we recommend looking at a year’s worth of data to make sure there is no seasonality in costs," says Pryor. "We also recommend making sure the pilot project is sized so it can be completed in 90 days or less. Otherwise you lose momentum and focus."

Pryor adds that the time required will vary according to the size of the organization and the staff the organization commits to the project.

"The general recipe is that if a business has 10 cost centers, groups of employees, or activity centers [such as administrative staff, billing staff, clinical staff, etc.], and if someone can spend 25% of their time asking employees about their activities and collecting cost information for workload measures, the analysis could be completed in less than 45 days," he says. The 45-day timetable will fluctuate from one organization to the next depending on variables, such as there being fewer or more than 10 cost centers or the analysis taking more or less than 25% of one employee’s time.

Software, consultants, colleges can help

Pryor says the cost for such an initial pilot project can vary widely. Near the low end, ICMS sells self-implementation tools that cost $995.

"It is PC-based software along with a case study and ABM dictionary for anyone who wants to implement this themselves but needs tools to assist them," says Pryor.

He adds that even with such a starter kit, you’re not necessarily on your own.

"If you don’t have the time or skills, call your local college," says Pryor. "There are professors and students actively looking to get hands-on experience implementing ABM or ABC. That would be a low-cost way for a business owner that doesn’t have the staff, time or money."

If you’re willing to spend a little — or a lot — more time and money, you can attend a workshop or even hire a consultant to come in and get the work done for you. According to Pryor, the price tag on the latter option can run anywhere from $10,000 to $50,000, depending on size of organization.

3. Put it to use.

Having compiled the activity and cost center information isn’t enough. You’ve got to put it to good use. Pryor says there are two basic categories of uses for the information.

Cut the fat.

"You can use the activity information to identify continuous improvement opportunities, meaning you’ll be able to define which activities are high cost [in relation to output of work and value-added benefit to clients]," says Pryor. "If you were to do common-sense benchmarking, these activities would be areas that would enable you to improve your bottom line through basic cost reduction."

In his experience implementing ABM, Pryor typically sees a minimum amount of non-value-added cost of 20%.

"It would be very common for a home infusion provider to find that 20% of their business and overhead costs are non-value added waste that doesn’t add customer value."

Velma Goertzen, RN, and the general manager of Health-E-Quip, a home medical equipment (HME) and oxygen provider in Hutchinson, KS, has seen such dramatic improvement first hand.

"There are not many home infusion or HME providers who have implemented this, but we were hit with a 25% cut Jan. 1 for oxygen reimbursement, so I started looking at where we could cut costs without cutting quality, because we were 60% oxygen."

Health-E-Quip implemented ABM last August and has seen a profound impact on its business.

"Instead of a negative bottom line, we’ve got a solid, positive bottom line, and we did that in about six months," says Goertzen.

Improve decision making.

"Of the activities, you can look at how they relate to your products, services and customers," says Pryor. "Rarely in home infusion does an owner know where they are making money and where they’re not, because all customers are not created equal."

With the information at hand, you can analyze what type of business is most beneficial to your bottom line, and conversely, that which may not be worth the effort. But Pryor cautions against simply looking at profitability without putting the information to use.

"I emphasize that because I see too many businesses use the activity information only to determine where their profitability is, and all it does is reallocate existing costs more accurately," says Pryor. "That will give you some insight, but most business owners want improved profitability, not just improved profit-activity costs."

4. Update.

To make sure you’re always working with the latest figures, and to keep the process ongoing, Pryor recommends updating your figures on the spreadsheet.

"You should update the costs, activities, and workloads four times a year, unless you are very large, in which case you would update monthly," he says.

Pryor notes that it takes only two or three days to update ABM data if done properly.

"Involve every manager in the updating process," he says. "Spread the workload and learning."

You must obtain employee buy-in

Pryor notes that many business owners don’t tell employees the consequences of improving or acting upon the findings.

"As a business owner, you need to create a positive and negative consequence. Otherwise, the employees tend to dwell on the negative and ask, What’s in this for me?’"

Goertzen agrees that employee buy-in is a necessity.

"This cannot be done with one person," she says. "It has to be done by the whole organization." Only with the entire staff evaluating your procedures and looking for ways to cut costs will you fully realize the benefits of ABM.