Budgeting Concepts

The economic climate for the future of health care is uncertain and with increasing competition for funds, financial resources are becoming scarce. The nursing department budget can account for as much as half of a hospital’s total expenses, so there will be significant pressure upon nursing to increase efficiency and effectiveness. For nursing to respond, managers at all levels must become proficient in the budgeting process. This proficiency will provide the resources necessary for safe and effective nursing care.

The nurse manager has responsibility and accountability for the nursing budget. Without a budget, each department may operate without regard to what any other department is doing or to the organization’s objectives. This lack of coordination results in inefficiency and increasing cost. The operating budget becomes the master plan of action for the entire organization, reflecting the coordinated efforts of all levels of management. This helps the organization to operate smoothly and efficiently so that goals and objectives are met. The enlightened nurse manager knows that whoever controls the budget is in control of the department. Managing the financial end of nursing through an operational budget can obviously create a new dimension for the charge nurse.

Accounting is the language by which an organization understands where it has been in financial terms. No sound decision-making is possible without an understanding of the finances. Budgeting is an ongoing activity in which revenues and expenses are managed to maintain fiscal (financial) responsibility and fiscal health. It is the process of planning and controlling future operations by comparing actual results with planned expectations. Budgeting can be a motivational force for personnel if:

• Current programs must increase effectiveness and efficiency to remain within the budget
• Staff involvement provides an increased sense of responsibility and satisfaction
• Merit increases, promotions and bonuses are tied to budgetary performances.

The budget can be dysfunctional and fail to facilitate attainment of organizational objectives when it is viewed as an end rather than a means. This happens if:

• It is inflexible and permits no deviation from the established plan.
• It is viewed as being externally imposed by administrators who do not understand patient care.
• Health care providers feel left out of budget decisions.
• There is over emphasis on staying within the budget, leading to a decrease in interdepartmental communication and cooperation.
• Managers are held accountable without being given authority.

There are three broad activities involved in the budgeting process for any organization: 1) identifying costs, 2) identifying revenues, and 3) evaluating the financial dimensions of projects or investments. These activities provide the necessary background information needed to make reasonable and realistic decisions. Understanding the financial aspects of activities allows budgeting tools to increase productivity; expand the unit’s achievement; and expand the manager’s power within the organization.

The basic unit of organization for financial purposes is commonly called the “responsibility center.” It may be a department or a division or some other operating unit or a grouping of operating units. The responsibility center is an entity for purposes of monitoring flows of funds. If a responsibility center handles in-coming funds (revenue) and out-going funds (expenses) it may be called a “revenue center.” If the center only handles expenses it may be called a “cost center.” Cost centers are usually departments that provide services that do not directly draw revenue. 

“Value for money” is a concept that is related to budgeting. This concept means that the unit or the organization is getting full value for the money expended. It includes factors like turnover of personnel, waste of supplies, ineffective use of clinical skills and inaccurate staffing standards.

Budgetary planning assures the best methods are used in achieving financial objectives. In nursing, budgetary planning helps ensure that clients will receive the nursing services they want and need from satisfied nursing workers. A good budget should be based on objectives; be simple; have standards; be flexible; be balanced; and use available resources first to reduce expenses. Planning needs to provide contingencies by indicating what programs or activities can be reduced or eliminated if expenses exceed budget goals.

During budgetary planning the expense and revenue projections are reviewed together and compared. If they are out of balance, the expense budgets will be reviewed to seek ways to reduce expenses without impairing the services that support revenues. The revenue budget may also be reviewed to identify ways of increasing revenue without significantly increasing expenses or impairing the quality of services.

The budget is a detailed, operational management plan or schedule that communicates the organizations financial expectations. It is stated in terms of income and expense. The budget is used to compare expectations to actual results. It is a tool that can aid decisions makers in evaluating operating performance and projecting what future operations might produce. The budget shows how resources will be acquired and used over some specific time interval. This allows management to project activities into the future so that the objectives of the organization are coordinated and met. It also helps to ensure that the resources necessary to achieve these objectives are available at the appropriate time. A budget helps management plan and control the organization.

A budget is a best estimate of nursing revenues and nursing expenses. The nursing service budget is used for three purposes: 1) to plan the objectives, programs and activities of nursing service, 2) to motivate managers and nurses, 3) as a standard to evaluate performances of nurse administrators.

The master budget, which is some times referred to as the operating budget, represents a series of interrelated budgets for all activities of the organization for the budget period. The master budget is a summary of all the other budgets. It is the end outcome of the budgeting process. The operating budget is usually developed to cover a one-year period that corresponds to the organization’s fiscal year. Most organizations will then divide the one-year budget into four quarters and each quarter into the separate 3-months.

Continuous budgets are sometimes used. These are budgets that add one month into the future as the month that just ended is dropped, so that there are always 12 months of budget data before management. Continuous budgets are desirable because they compel managers to think specifically about the coming 12 months. A continuous budget may also be called a perpetual or rolling budget.

Zero-base budgeting is a budgeting process that requires managers to start from zero budget levels every year. Managers are required to justify all costs as though they were being initiated for the first time. No cost is viewed as continuing into the future. Proposed budgets have been justified on an incremental basis: the manager starts with last years budget and adds to or subtracts from it according to the projected needs and objectives. The need for the activity must be validated. This process requires time and is costly but justified in some situations.

Revenue budgeting is the process in which a hospital determines revenues required to cover anticipated expenses and to establish prices sufficient to generate that revenue. To remain viable hospitals must make sufficient revenue to cover operating costs and generate profit. All hospitals have to make a profit to maintain their services. The term non-profit hospital just identifies a facility for tax exemptions only. It means that all the profits are put back into the business to improve the facility and services. The term for-profit hospital means the facility has owners or stockholders who receive a share of the profit. For-profit hospitals must pay normal business taxes.

The revenue budget projects the earned income (revenues) that can be anticipated by the institution. The costs of nursing service have been identified for many years, but the income earned from provisions of nursing services has been bundled into the “bed and board” charges for the hospital. Advance practice nurses may generate a direct charge for their services. Nursing divisions can obtain direct income from grants, selling staff development programs, consultation services, home health care, wellness programs, computer software and many other products.

The expense budget funds the routine equipment and supplies needed to operate a nursing unit. Expenses are the cost of providing services to patients. They are frequently called overhead. It includes wages and salaries, fringe benefits, supplies, food service, utilities, and office and medical supplies. All expenses are grouped into categories for budgeting purposes. For instance, paper and staples are put into the office supply category. Thermometer covers and bedpans are put into the medical supply category.

The expense budget is part of the operating budget. It does not include capital equipment and supplies charged directly to patients as revenues. Capital equipment is equipment that is expensive; expected to be useful over many years; and is not a part of the day-to-day unit expenses. Like buying new beds or monitors. The purchase price criteria for defining capital equipment are determined on a company-by company basis.

The expense budget is a commitment to the planning decisions. It is a balancing act and managers gain stature by the extent to which they can achieve the balance through their skills. They are respected and sometimes rewarded if they can control expenses, running a “taut ship.” So, managers have an incentive to submit low budgets. However, they must also achieve the objectives of the organization for quality care and staff satisfaction. This provides incentive to pad the budget, to ensure that they will have enough resources. The best managers strive to know their costs as accurately as possible, so they can achieve the organizations goals for their units. When skilled managers submit higher budget proposals than expected, the budget reflects expanded goals not padded expense figures.

An essential tool used in developing this budget is a report of expenses. This information should be available for each expense category. Changes in supply requirements or utilization can result from changes in the number of patients: a change in the degree of severity of patient’s conditions; a change in type of patients; or changes in equipment needs. This budget also has to be adjusted for inflationary impact. The purchasing department can provide guidelines for this.

A monthly expense statement helps monitor this budget. To determine causes for variations, the activity level of the unit should be examined for any relationship to the variance. If the variance is due to improper utilization of supplies, then a plan to correct the situation should be developed. At times it may be necessary for the manager to make staff aware of budget overruns and ask for assistance in conserving supplies.

Direct expenses include items under direct control such as salaries and benefits of the staff in the unit, supplies used, outside services contracted (e.g., agency nurses used to fill staffing gaps), or any other expense incurred as a direct result of a decision by the manager or a staff member. Because these are expenses the manager is expected to control, they must be estimated as thoroughly as possible. Some important considerations include:

• Any changes in supplies used that might affect supply costs
• All staff development costs
• Realistically estimated cost of staff turnover, particularly in overtime and fees for agency staff.

Indirect expenses are apportioned or allocated expenses for services necessary for the operation of the unit that are not under the direct control of the manager. The most general example of this would be expenses for building maintenance and utilities such as heat and light. Obviously these are not direct expenses but are expenses that are incurred by a maintenance department. The difficult problem here is that the operation of the nursing service requires that a boiler in the heating plant be maintained, but every other department of the institution also requires the boilers maintenance. Most institutions have a formula by which costs are allocated. Such a formula will be designed to comply with guidelines of third party payers on how costs can be allocated in order to be acceptable for reimbursement. In some large hospitals indirect costs may be allocated by complex computer programs that consider how each department interacts with and supports or draws support from each other department.

The capital expenditure budget is established to fund the purchase of major equipment or projects like expansion, improvement or replacement of the physical plant and equipment. The capital budget projects the investments needed or desired in a facility and identifies sources of the needed funds. Each item of a capital budget is defined in terms of dollar. Criteria for capital budget are that the item must be above a certain dollar cost and have a life expectancy greater than a set time period.

The budget provides for depreciation of each capital budget item. This is an accounting tool that allows the company to allocate the expense of an item over its useful life. It is intended to give a realistic picture of month-to month operating expenses in relation to the income generated by the capital equipment.

Capital budgets also include land purchase, buildings (maintenance, renovations, remodeling, and replacement) and replacement of existing equipment. The need for each item in the capital budget should be well documented. All proposals for capital equipment need to be fully evaluated for amount of use, payment methodology, safety, replacement, depreciation of service and every conceivable angle, including the need for space, personnel and renovation.

Personnel budget is the salary/manpower budget for a particular unit or cost center. Besides salaries it includes compensation for vacation, sick leave, holidays, overtime and merit increases. When computing the personnel budget the following factors must be taken into account:

• Patient census or unit activity indicator
• Mixed patient acuity
• Changes in medical practice
• Clinical service or change in service
• Support services
• Plans for the next year

Required hours of nursing care is a measure to help estimate staffing needs in budget planning. The first step in calculating staffing is to find the patient days by level of acuity from historical data. This information can be obtained from the census reports and patient classification system data.

A patient classification system uses criteria to measure patient acuity of illness and links the acuity to the level of care required for that patient. These systems generally capture nursing procedures or task that can be correlated to the amount of nursing time required for patients who need those common procedures or tasks. That nursing time is called the standard hours of care. The standard hours of care needed for each acuity level is a determination that was established and validated when the patient classification system was developed.  A standard hour is management’s best estimate of the amount of nursing time necessary for each kind of patient. The following is an example of one type of patient classification system measurements:

The next step is to determine the hours of nursing care required for the unit’s mix of patients. To determine the daily hours of nursing care required, multiply the number of patients of each type by the standard hours of care for that type.

The following example assumes that the data is given to you in the form of an average per day.  This form would require you to forecast for the year by multiplying the average per day by 365 as follows:

Using the recommended hours of care as a guideline, the manager can distribute those hours over all shifts by developing a staffing grid. When doing these factors such as personnel mix, hours of work, distribution of workload, delivery system and support staff must be considered.

• Personnel mix – this includes the number of personnel currently available at each skill level (RN, LPN, CNA) as well as skill level recommended due to patient acuity.
• Hours of work – whether 8-hour, 10-hour, 12-hour or other flexible scheduling work shifts will also affect the staffing pattern.
• Distribution of workload – requires analyzing the workload distribution over the shifts and determining how the staffing should be distributed.
• Delivery system – is the method of delivering care – primary, team or functional.
• Support staff – this includes the availability of unit secretaries, unit aids, technicians or other staff who would not be included in the direct care hours, but who do provide an essential support often referred to as indirect hours.

Once unit-staffing requirements have been determined, the hours must be converted to dollars by multiplying the hourly rate for each employee. You should estimate the salary rates for those positions that may be empty.

Merit increases also need to be considered and included in the budget. To calculate the amount to include for merit increases, multiply the amount of the increase by the number of hours to be paid at the new rate. Budgeting for differentials for evening and night shifts are calculated by multiplying the hours for that shift by the differential rate.

An overtime budget is established to cover situations that cannot be anticipated such as fluctuations in workload or temporary shortages. Overtime should be calculated by determining the average number of overtime hours worked and multiplying by one and one half times the hourly rate. When historical trends are used to predict overtime the manager should consider whether the amount of overtime used in the past year was really justified and whether the level predicted is really appropriate. It may be possible to reduce overtime by adjusting the staffing schedule.

At this point accumulation of data for the personnel budget should be complete. In summary, the first step is to project the activity for the coming year in terms of patient days and acuity of illness. The daily hours of care required for the projected mix of patients are then calculated by using the standard hours of care. A staffing pattern is then developed and the annual hours of care are converted to actual salaries. The final step includes the calculation of differentials, overtime and indirect labor costs.

Depending on the level of computer support, some of these calculations and projects may be done for you. If so be thankful, but don’t accept those calculations as fact. Evaluate the data to be sure it is about what you expected. Do not panic. You are not expected to do a budget by yourself the first time. Ask for help.

Once the overall budget has been drafted, high authority must approve it. Generally, in a non-profit healthcare organization the board of directors or trustees will approve the overall budget; the components of that budget will be approved in finer and finer detail by the responsible administrators down the line of authority from the board. The hospital administrator would approve the nursing-service budget within the overall budget; the nursing director would approve the nursing unit budgets and so on. Once the budget is approved, the managers must implement it. The manager of the responsibility center is responsible to see that expenditures in the center are made only in accordance with the approved budget.

Constant monitoring is necessary to assure that expenses remain within the projected budgetary limits. This calls for use of monthly expense statements, which include the amount budgeted for the month. When a manager receives feedback on actual expenses, the data will show where there are differences between budget projections and the actual results. These differences are called “variances.” The report should be analyzed for significant variances. Most budgeting systems include policies on the amount of variance that can be accepted without investigation or remedial action. The causes for the variances should be determined and corrective action should be taken when indicated. It is acceptable to be under budget. The areas of variance that require the most effort in problem identification are those that are significantly over budget.

In order for the manager to maintain proper control over the budget she requires information about the expenditures. The manager may realize, for example, that there has been an unusual amount of overtime on the unit. If the manager has monthly information on actual salary expenses, the manager will know whether the budget has been exceeded and by how much. The manager can consider actions that can alleviate the problem, given firm knowledge of its precise event. An astute nurse manager will do her best to know what variances are occurring in the budget.

When variances become significant the next level manager should be involved especially if adjustments are needed. It may be necessary to add additional staff if significant variances are due to increased salaries incurred with overtime or agency staff. If the need appears to be relatively enduring, it may be recommended to increase the budget to permit hiring additional staff or change the system of nursing-care delivery.

As cost containment issues capture the minds and hearts of health care industry leaders, the issues of controlling dollars spent has become crucial. Managers are being taught about salary expense and revenue budgets. Expenditures excessively over and under the budget require explanations. This area of responsibility can have positive effect on strengthening the managerial role. However, unless it is matched by authority to make decisions about revenues and expenditures it will become a troublesome burden and liability.

Budgeting is the process of planning future operations and controlling operations. By measuring these differences between actual and expected budget items, management is better able to make modifications and corrections.

Since the nursing department budget can account for as much as half of a hospital’s total expenses, there will be significant pressure upon this department to increase efficiency and effectiveness. For nursing to respond to the pressures and the uncertainty of the economic climate, nurse managers at all levels must become proficient in the budgeting process.

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Sullivan, Eleanor J., and Decker, Phillip J., (1998) Effective Management in Nursing, Addison-Wesley Publishing Company, Menlo Park, CA.