Many researchers agree that health care organisations are the most complex systems. Therefore, they are difficult to transform, manage or restructure. However, this becomes possible through strict management procedures and good financial and cost management. The author of the paper looks into the complexity of cost behaviors in health care organizations and thoroughly describes how costs are classified according to their relationship with volume. He also examines the importance of cost allocation and how it may be leveraged by the health care organizations.
Cost behavior refers to the relationship between the cost of particular item and the quantity of the related cost drivers (Hartgraves, 2012). Therefore, it explains how the total amount in cost is arrived and corresponds to the changes in activity volume. By understating the cost behavior firms are able to estimate the future cost. Specially, cost behavior depends on specifics units of cost that are cost center. Cost center refers to departmental unit which a manager is assigned the responsibility for cost (Finkler, Kovner & Jones 2007, p.138). Some costs are stable therefore, little or no changes occur even with changes in patient workload (Finkler, Kovner & Jones 2007, p.138). Whereas, other costs are dynamic, reacting directly to changes within the organization.
This section seeks to give a framework to create an understanding of how costs behave in a health care organization (Finkler, Kovner & Jones 2007, p.138). Cost evaluation is a complicated process. For instance, when being asked about the cost, the majority of people respond with a direct answer, which is not correct. The reason behind this is following: the measure of cost hinges on the intended use of the cost information. The last year’s cost of treatment of a patient is different from the present day cost. The cost per patient of treating 100 patients maybe very different from the cost per patient when treating 50 patients therefore it becomes very complex for the health manager to determine the cost and he or she must rely on consistent set of definitions. The definitions ensure effective communication and enhance the interpretation of information.
A service unit refers to basic measure of the product or service being produced by a firm. In the healthcare sector this may refer to patient days, home care visits, treatments or operations (Finkler, Kovner & Jones 2007, p.139). This concept is important to health care managers since they understand it pertains to an area of responsibility. Direct cost is another concept that is often difficult to grasp because it is dependent on the object of analysis. Thus if the manager wants to find out the direct cost of patient care he should refer to the costs of resources for direct care of the patient (Finkler, Kovner & Jones, 2007, p.138). This would not include time spent on administrative duties by the manager or cost of the clerical personnel and others. At the same time, costs that are assigned outside, such as housekeeping or laundry are the indirect costs. Total cost includes all the costs associated with an organization unit. It includes both direct and indirect cost. For instance, all the hospital cost would represent the total cost. Moving department by department it does not include the direct cost, but also all indirect cost as well. Average cost is derived from the total cost by dividing the volume of service units. Managers face a number of questions to answer which they need the information about the cost per patient, per patient day and per treatment (Finkler, Kovner & Jones 2007, p.139). Cost centers may use their service units to calculate the average cost.
These costs are referred to as fixed costs. Fixed costs are those costs that do not change in total as the volume of service unit changes. Whereas, supplies used for patients care changes directly with changes in the volume of service units (Finkler, Kovner & Jones 2007, p.139). A clear definition of a service unit is important in defining fixed and variable cost. Even though clinical supplies vary with number of patients per days, specifically, operational supplies will likely vary with the number of operational procedures and the clinical supplies with number of clinic visits. It is important to note that fixed costs are fixed over the relevant range. For instance, suppose that a nursing unit has 80 % occupancy rate; if the occupancy rate exceeds 100 % it would be reasonable to increase the nursing units too. In such a case, the fixed cost would rise. Thus the fixed costs are fixed within a relevant prescribed range.
Marginal costs are the costs incurred as results of offering one more service unit. These costs offer important information in the decision making process. Managers are able to estimate accurately how cost changes when the number of patient changes. The marginal costs include both variable and fixed costs by adding an extra group of patients (Finkler, Kovner & Jones 2007, p.139).
Mixed costs are the costs that contain both fixed and variable cost elements. Let us take electricity as an example. The service unit use electricity everyday in hallways but it is not related to the number of patients. This presents a fixed cost (Finkler, Kovner & Jones 2007, p.140). However, electricity used in operating theaters varies with the number of operations. Therefore, this is a variable cost in the hospital. For the mangers, the mixed cost is hard to estimate since if the volume service unit costs rise by 20% one would expect that the variable cost would rise by an equal amount. But the mixed cost would rise by an amount less than 20% and greater than 0%. It is crucial to provide a strategy in estimating the change in the mixed cost resulting from changes in the volume of service units.
Cost allocation refers to the process of identifying and assigning the costs of services needed for a company to effectively operate (Finkler, Ward & Baker, 2007). Cost allocation helps managers to determine the amount each item produced or service cost. In the health care sector cost allocation will help the organization to stay on budget, since the cost services will meet the profitable goals and the managers will be able to track and manage inefficient or ineffective operations (Finkler, Ward & Baker, 2007). The use of the budgets is a common practice in the healthcare sector. Operations within various departments follow specific budgets. This forms a cost control mechanism that ensures low costs since items purchased are not over priced. This practice severely increases the profits and the hospital efficiency (Finkler & Ward, 1999).
Any firm has some profit goals, which are achieved through the sale of goods and services. Profits are obtained through the sale on an item above the cost to produce. Dividing the profit by the sales price we obtain the profit margin per service unit (Finkler &Ward, 1999). The profit margin can be increased either by increasing sales or reducing the cost of production. Therefore, with an ineffective cost allocation practices, the hospital may not know how to reduce the service unit cost.
Hospitals can have a number of inefficiencies in operation that raises the operational cost. For instance, the hospital may allocate too many nurses to a service unit (Finkler & Ward, 1999). These nurses increase the service unit cost through extra wages. If managers can determine where these inefficiencies exist, the problem can be easily eliminated from the system. Therefore, the improvement of the hospital’s operation and the reduction of the service cost to the expected range allow to maximize the profits.
Constant review of the organization’s cost behavior and allocation should be ingrained into the organization’s culture and practices. This will allow the organization to constantly assess its operations as compared with other analogical organizations in the market. Moreover, it will allow the organization to devise strategies and to manage its earnings by applying different cost behaviors and allocation method. Such alterations can move the organization from a conservative income approach to an aggressive approach or vice versa.