Variance reporting in traditional hospital fixed and flexible budgets seldom, if ever, provides both meaningful and useful information upon which appropriate management decisions can be based.  Our approach to flexible budgeting is designed to overcome this problem.  The purpose of this presentation is to illustrate this point.

Table of Exhibits for Example Department (#101):

Exhibit 1:  Forecasted (fixed budget) and actual units of service 
Exhibit 2:  Typical fixed budget variance report 
Exhibit 3:  Traditional flexible budget variance report 
Exhibit 4:  eTBA flexible budget
Exhibit 5:  Efficiency variance analysis 
Exhibit 6:  Monthly variance report supplement
Exhibit 7:  Monthly labor review
Exhibit 8:  Optimal staffing comparative report

We are assuming:

• The goal is to analyze the November 1989 Variance Report for Example Department (#101) at eTBA Regional Hospital; and

• Forecasted (fixed budget) and actual units of service for Example Department in November are as shown in Exhibit 1.

The remainder of the Appendix contains sample reports and narrative contrasting variance reporting for Example Department between the following:

• Fixed Budget

• Traditional Flexible Budget

• eTBA Flexible Budget

Due to the significance of labor cost, and to keep the comparison fairly simple, only the labor portion of variance reporting is addressed in this presentation.

Fixed Budget

A typical fixed budget variance report for Example Department appears in Exhibit 2.

A management analysis of this report would probably first focus in on the Gross Margin, noting a $2,781 (9.09%) favorable variance.  Some managers would accept this as evidence of good performance for the department and devote little, if any, attention to the other details of the report.  Others might take their analysis a little further.  For instance, they might compute the gross margin percent and note that the actual percent (33.02%) is greater than the budgeted percent (32.71%).  This is obviously favorable, and that might be the end of the analysis.  Other managers might suspect that with the increased volume, perhaps gross margin should have been higher than was actually achieved. They would then focus their analysis on the variance analysis portion of the labor expenses. However, this becomes a very difficult task, even for the manager with a solid finance background.  Many different variances are shown. The total labor variances indicate that the department was quite efficient given the increased volume demands, but that the actual hourly rate of pay was quite excessive.  However, an experienced accountant would know that such a conclusion is erroneous.  The Other Productive (overtime, agency, etc.) variance always is depicted as a rate variance when there are no manhours or dollars budgeted for that expense.  In reality, this apparent $5,000 unfavorable variance is probably primarily an efficiency and/or volume variance.  However, with this type of budget, there is no way to determine the exact nature of the variance.  An alternative around this problem, and one utilized by many hospitals, is to combine all variable salary accounts into one line item on the budget.  This results in more accurate variance analysis. But there is a major trade-off to this approach.  Although the nature of the variance may be appropriately categorized, it can not be Isolated and attributed to the appropriate categories of expense (e.g., by job code and differentiated between core staff and other productive hours).  In summary, variance analysis in connection with a fixed budget is of limited use.  In fact, many hospitals with fixed budgets do not perform variance analysis.

Traditional flexible Budget

A traditional flexible budget variance report for Example Department appears in Exhibit 3.

Note that, in comparison to the fixed budget in Exhibit 2, there are no volume variances. The budget has been "flexed" to reflect actual volume for the month. The budget to actual comparison here shows an unfavorable variance of $706 for gross margin compared to a favorable variance of $2,781 on the fixed budget. Even If the fixed budget $2,161 volume variance is subtracted from the $2,781 total volume variance on the fixed budget, the resulting $620 gross margin variance is still favorable. This further illustrates the problematic nature of variance analysis with a fixed budget. As previously discussed, part of the Other Productive salary variance of $5,000 in the fixed budget is obviously a volume variance.

Analyzing labor variances in the traditional flexible budget is every bit as difficult as it is in a fixed budget. Every so-called variable labor account will invariably show a total variance. This will also be the case in those instances where Other Productive labor (overtime, agency, etc.) is not shown separately, but combined with the applicable job codes. The vast majority of the variances are really "false" variances.  This will become more readily apparent in the discussion of the eTBA Flexible Budget.  In summary, variance analysis with the traditional flexible budget is only marginally better than that obtainable with a fixed budget. In both cases, false and confusing messages are sent to management and resultant erroneous conclusions are reached. They are tools used with much trepidation.

eTBA Flexible Budget

The major differences between the eTBA approach to flexible budgeting and the traditional approach are:

• The eTBA approach is based upon the relationship of weighted units of service to each separate skill level in the department (RVUs by Job code). This approach recognizes that changes in the mix of a department's output has a varied impact on the different categories of employees within the department.  Traditional flexible budgets "flex" payroll either on unweighted units of service or one overall total for weighted units of service applied Indiscriminately to all skill levels.  Thus, the traditional approach has a built in logic error.

• The eTBA approach to variance reporting of labor cost better distinguishes between true variances and false variances.  For Instance, core staff regular payroll costs are not flexed (except in supplemental informational reports).  Flexing occurs only with respect to other productive hours (overtime, agency, float, etc.). This feature reflects the reality of the workplace, whereby core staff is essentially a fixed cost in the short-term and increased workload demands are met with other productive hours. As a result, false variances are nearly eliminated and the budget assumes a far greater level of integrity.

• Recognizing that prudent management should not be based upon a single month's variance analysis, the eTBA approach incorporates variance trending reports. These reports are useful supplements to monthly and year-to-date variance reports, particularly with respect to core staffing decisions.

Exhibits 4 through 8 provide examples of eTBA flexible budget variance reports for Example Department.

Contrast Exhibit 4 to Exhibit 3.  For ease of comparison, the total flexed labor dollars in both reports were kept identical. In reality, there would be a difference, as explained under the first bulleted point above. Note that Exhibit 4 is a much "cleaner" report.  Variances shown for core staff are only hourly rate variances. False efficiency variances have been eliminated. Although there is still a sizeable unfavorable efficiency variance for Other Productive labor, is not the erroneous inflated variance depicted in Exhibit 3. Exhibit 4 tells the reader that, during November, Example Department had some positive and negative hourly rate variances and a fairly sizeable unfavorable efficiency variance for Other Productive labor. Exhibit 5 shows the composition of the efficiency variance.

Although Exhibit 4 Is much more useful than Exhibit 3, It doesn't tell the reader whether or not there Is sufficient core staffing, or if the mix of skill levels is the most appropriate from an efficiency standpoint. In addition, it is only a snapshot of one month's operating results and not necessarily indicative of customary performance or trends. Exhibits 6 through 8 help address these issues.

Exhibit 6 is a "what-lf supplement to the variance report depicted in Exhibit 4. It is identical to Exhibit 4, except that core staff has been flexed in response to the volume of activity for the month. Note that the corresponding flexed Other Productive labor cost is less than the amount shown in Exhibit 4. Exhibit 6 shows that, based upon November's activity, there is need for one additional Tech II (at $2,000 per month), and what the Other Productive labor cost should be If staffed at that level. Note that the department would be expected to be more efficient at that level of core staffing. Exhibit 6 is depicted as a "what-lf report since it is based upon 20-20 hindsight. It shows what costs should have been had the department manager known in advance what the volume and mix of activity would be, and had the department manager received authorization and been able to hire one Tech II on or before the first day of the month.

That is why Exhibit 4,rather than Exhibit 6, is utilized as the primary variance report for the department manager.   Typically, staffing level authorization is restricted to executive level management. Exhibit 6 seems to indicate a need for an additional Tech II in Example Department. However, the activity levels for November could have represented an anomaly.  Decisions to add or delete core staff are usually based upon longer observed trends.

Thus, Exhibit 7 is useful in deciding whether or not to authorize the hiring of an additional Tech II. Note that November is the third consecutive month that the cost management system has
indicated a need for one additional Tech II. Both Exhibits 6 and 7 incorporate additional unique features of the eTBA approach. First, the flexing of core staff is done on a step function basis in increments appropriate for the applicable job code (e.g., full FTEs, half FTEs, etc.).  Second, flexing of core staff Is performed based upon deseasonalized volumes of activity. Flexing of Other Productive labor hours is based upon actual activity (not deseasonalized). These unique features are Incorporated to mirror the realities of the Hospital's environment and to produce more meaningful information for management use.

Exhibit 8 is an example of the integration of productivity monitoring subsystems into the overall cost management system. In this example it is assumed that an operations review of Example Department Indicated that the skill mix in the department could be changed by substituting seven Tech Is for seven Tech Us and by eliminating one Supervisor position, resulting in reduced operating costs. However, until these goals are reasonably attainable, they are shown as reconciling differences between the budgeting and productivity systems.  Exhibits 4 through 8 are examples of reports that can be generated with the eTBA approach to flexible budgeting. They are by no means all-inclusive.