Has this ever happened to you? You go to dinner with three other people, all of whom eat more than you. At the end of the meal the waiter hands the check to one of your dinner companions who proceeds to say, “Let’s make this easy and split the check four ways.” You end up paying more than you ate while your friends just got something for free. You sit there telling yourself, why didn’t I ask for separate checks?
It would be prudent and smart for home medical equipment (HME) providers to create “separate checks” for their products, services and customers. Traditionally, HME owners have assumed that all overhead expenses apply equally to all products and customers. As an example in Table 1, this business owner would be led to assume that every dollar of revenue consumes 27 ½ cents of overhead expense. Intuitively, business owners recognize that certain sales transactions consume more overhead cost than others, e.g. a delivered order consumes more cost than a customer pick-up. But monthly accounting reports don’t report the “facts” to confirm these “feelings” (see Table 2).
To address the need for financial facts, home care firms are using Activity Based Costing (ABC) to create “separate overhead cost checks” for their different types of customers, services and product lines.
What is ABC? Activity Based Costing is based on a simple principle … activities consume resources and customers consume activities. Associating the labor and overhead expenses of the business with the activities that consume those resources provides valuable facts. Financial facts that can be used to improve decision-making and identify cost improvement opportunities.
The basic building blocks for ABC are activity accounting spreadsheets for each group of employees in the business. Typical groups in a home care company would be Delivery, Billing, Customer Service, Therapy, Repair, Sales & Marketing, Accounting, Purchasing and General Administration. Table 3 shows an activity accounting report for a typical home care billing department … the columns are the activities and the rows are the resources. The workload of each activity is measured resulting in a cost per output. As is often the case, the average cost of re-submitting a claim is more expensive than the initial submission.
Steps to Implement ABC Implementing ABC is a Five-Step Process:
Uses of ABC I have heard it said that the lottery is God’s way of punishing people who are bad at math skills. I believe the same can be said for the use of 1940’s-style accounting reports (Table 1) in 2000’s home care. The management of gross margin percentages is simple. But in today’s competitive marketplace, a focus on gross margin is simplistic. Traditional accounting reports are formatted for external compliance reporting, e.g. I.R.S., banks, etc. ABC is formatted for internal decision-making.
HME owners are increasingly discarding their monthly focus on traditional accounting reports and periodically using ABC to help make many types of decisions:
Here are some examples of “how to use” ABC:
Fire customers that consume more activities than their gross margin will cover! But before you “fire” any customer, add to the decision their accounts receivable balances and payment histories. What you will often find is that not only are you not making money on their orders, but you are also banking for them with your accounts receivable as well.
ABC customer profitability analysis not only identifies profitable and unprofitable customers, ABC also provides methods to turn losers into winners:
Many HME owners need more shelf-control when it comes to which products and services they should offer customers. Published gross margins can be misleading. For example, one home care firm met with a sales rep that wanted to demonstrate a useful new product. The new product had a recommended list sales price that results in a 20% gross margin. Normally the home care owner would not have carried the product because overhead costs are 27.5%, resulting in a pre-tax loss of 7.5%. But the business owner, using the principles of ABC, realized that many of the home care overhead activities would not be incurred with the sale of this new product. With this ABC knowledge, the owner decided to add the new product to the sales shelf. The product became a big seller for all the branches, adding significant profits to the company. ABC helped the owner make a good shelf decision.
Menu-based pricing is another popular use of ABC. The most costly activities of a home care company are typically services that are being performed for the customer. The higher cost, higher volume activities of the home care firm serve as a basis for a menu of services and prices, e.g. Make Delivery, Process Return Goods, etc. If customers are not charged for costly activities, they may incorrectly assume that you’re providing the service for free! Creating an ABC Bill of Activities will alert home care managers if they can afford to sell what they are currently offering customers on the firm’s menu of services.
A recent personal experience highlights the importance of using ABC to set policies. My 79-year old father recently had successful triple bypass surgery. The doctor prescribed an oxygen concentrator on the Sunday my dad was released from the hospital. Someone on the hospital staff selected a home care firm to make the delivery. If the selected home care owner subtracted the cost of the activities consumed in the two-hour roundtrip delivery and subsequent return two weeks later, I seriously doubt that any profit would be left from the $228 fee. Apparently the home care owner had a policy of accepting any business, no matter the distance from the store. While noble, it makes little or no sense.
Repeat Steps 3, 4 and 5 for product lines, service types, branches or any cost object needing analysis. ABC provides insight as to where you’re making money and where you’re not in your business.
Cost versus Benefit Implementing ABC can provide significant benefits … improved pricing, better marketing strategies and more profits despite lower reimbursement rates. But there is a cost of implementing ABC. There are three basic implementation options that vary in cost:
Zig Ziglar defines disappointment as the gap between expectation and delivery. Many home care business owners expecting a reasonable return on their investment are disappointed with their current financial condition. And while they may get some temporary pleasure in blaming others … such as Medicare, Medicaid, HMO’s, Health Care Financing Administration … for current financial problems, it is up to every business owner to close the gap of disappointment.
In the newly published “17 Lies that are Holding You Back & the Truth that will set You Free“, author Steve Chandler lists number 8 as “I worry because I care. We worry because worrying is what we do all day to avoid taking action.” Worrying will not improve your home care company. Action will! Implement ABC. Create “separate checks” for your products, services and customers. Convert your profitability “feelings” into “facts”. Use ABC as the basis for a fresh start to your firm’s improved financial future.