Budgeting 101: How to Create & Manage Your Annual Budget

Financial and benchmarking analyses are an important part of management’s daily responsibilities in the senior living industry. However, with countless operational and other responsibilities and the significant amounts of financial data available, it can be difficult to efficiently pinpoint the most important metrics and outcomes needed to achieve financial success. One tool available to help predict and measure success is a robust budgeting process with regular follow-up.  

There are two basic forms of budgets your organization can use: static and flexible. Static budgets are set at a standard amount based on various assumptions and don’t fluctuate with changes in the volumes assumed. Flexible budgets are set at assumed inflows/outflows based on assumed volume but are adjusted each month based on actual volume achieved. See below for an example illustrating the difference between these two budgeting methodologies. A static budget results in three items to review for possible variances—volume, price, and efficiency—while a flexible budget removes the volume consideration and narrows the items to review for possible variances to two: price and efficiency.  

Regardless of the option (static or flexible) selected by your organization, you can make adjustments to your review and management of the results to fit the needs of your management team. Your organization will need to consider which type of budget will be most useful and easiest to create, review, and analyze on a regular basis.

Once management has determined the form of the budget, it’s important to engage leaders and departments throughout your organization in discussing and populating the budgeted inflows and outflows for each department. Using a participative method for creating a detailed budget brings in both varying perspectives for consideration and generates buy-in for each respective department, which will lead to greater engagement and better management of the budgeting process. You also should take this time to discuss the process by which department heads and management will be held accountable to the amounts determined. This might include a certain variance threshold that triggers specific comments by the department head as financial statements are completed each month, including comments on both why the variance occurred and changes that will be made for improved performance going forward, and a plan for formal signatures and approvals on monthly financial reports to document the process. This also might include identifying certain key performance indicators (KPI) for each department and tying performance metrics or bonus calculations to them.

In determining budgeted amounts, management will need to understand the organization’s basic metrics, i.e., number of beds, niche specialties, basic wage rates, etc., and the general makeup of the chart of accounts and internal reports used to manage the organization. Below are some budget considerations in three general areas:

• Income considerations:
  • Number of beds/units available
  • Historical occupancy and payor mix and plans to maintain or improve (consider changes in payors based on marketing efforts to increase certain admissions,  availability of a new payor like a Managed Medicaid product, etc.)
  • Room rates, including consideration of market price compared to competitors and compared to the ability to cover costs incurred and potential use of tiered rate increases (larger increases for new move-ins versus existing residents/tenants)
  • Upcoming trends that would require adjustment from historical trends (PDPM and other payment methodology changes, new service lines/niche services, etc.)
  • Per patient day (PPD) considerations, metrics, and goals

Once you have collected the items above, you can generate a revenue projection for the year. This projection will show the gross room and board revenues expected for each payor. The difference between gross revenues and the amount actually paid also needs to be considered. You can include this consideration with the items above to reach a net revenue calculation. You also should consider your historical collections by payor and plans to maintain or improve in estimating your provision for bad debts. While these items may be represented net on your income statement, it’s important to consider the various pieces in the budget process to isolate any adjustments necessary and understand the pieces that make up your organization’s net revenue. In addition, you may want to budget for additional nonoperating items such as contributions, investment income, and other nonoperating gains depending on the makeup of your income statement lines.

• Expense considerations:
  • Identify expenses that fluctuate based on volume and consider estimates based on volume budgeted for income items
  • Identify fixed expenses (rent, salaries, etc.) that won’t vary with volume
  • Identify any additional expenses due to the regulatory or general environment (COVID-19 considerations, increases in minimum wage or salary minimums, new contracts, etc.)
• Capital improvement considerations:
  • Determine large projects planned, including cost, expected completion, etc.
  • Determine known replacements that need to occur in the coming year
  • Review associated depreciation expense and verify that depreciation on capital improvement items above are considered in this budgeted expense

Once you establish a final budget, review the file to verify that formulas are calculating correctly and all general ledger accounts have been considered in your analysis. Compare your budgeted amounts to historical results and confirm you have sound reasoning behind any large fluctuations planned. Allow your department heads to review the budget for their respective areas and provide feedback. Management and department heads should physically sign and date a copy of the final vetted budget, and that support should be maintained in the accounting office. In addition, the budget should be approved by the board of directors, and approval should be documented in the board meeting minutes. These formal signoffs and approval will serve as support for the robust controls around your organization’s budgeting process.  

In conjunction with the budgeting process, management should identify the top KPI vital to your organization’s success and set a baseline (current values), as well as a goal for maintenance or improvement. The KPI identified for measurement can create a “scorecard” that management can use to determine the overall health of your organization and assist them in making appropriate and timely business decisions. There are many industry benchmarks available through public data sets such as Nursing Home Compare Claims, MDS-Based Quality Measures, CMS Payroll-Based Journal, and Medicare cost report data from the Healthcare Cost Report Information System. While this data is publicly available, it’s also voluminous and can be time-consuming to review and use. BKD has built a tool called BKD Escalate to harness this data so it can be easily compared to your organization. BKD Escalate goes beyond standard industry benchmarking practices by comparing a selection of KPIs against the BKD 500, which are facilities that have a strong balance of good financial performance and remarkable patient care. If you’re interested in using BKD Escalate to include KPI in your monthly financial analyses, please contact your BKD Trusted Advisor™ for more information.

One final item that should be included in your budgeting process for the foreseeable future is the potential for future operating and financial difficulties as a result of COVID-19. In these unprecedented times, there are many uncertainties that may be difficult to address when creating your next annual budget. For a detailed list of potential additional expenses to consider in both capturing items for reimbursement from various relief funding sources and budgeting for additional future expenses, see our recent BKD Thoughtware^® article. Below are some additional considerations you should make in your upcoming budgeting process:

• Effect on admissions and the potential need to use more recent history for projections 
• Discussions with referral partners and potential adjustments to future services to be provided for elective surgeries (will there be an increase as hospitals work through the backlog, or will the decline remain in effect for a period?)
• Effects of the unemployment market and child care/schooling difficulties on your staffing pool and the potential need to adapt scheduling or provide increases to recruit/maintain staff
• Continued increases in supply costs due to additional supplies needed and potential shortages
• Consideration of the need for additional staffing due to new duties for screening, sanitation, and distancing of residents
• Additional technology costs to allow residents to visit with family, attend telehealth visits, etc.
• If regular employee testing becomes required, additional costs for testing

In addition, management can document concerns regarding the uncertainties and possibility for significant variances in actual results compared to budgeted amounts due to COVID-19 by providing a footnote to the budget with that statement so it remains top of mind with governance and others involved in the budgeting process.

Whether your organization already has a robust budgeting process or you’re creating one for the first time, there’s no better time than the present to review your process, verify that you have engaged the right group of leaders to contribute, and ensure you’re creating amounts and using KPIs that help your organization make appropriate business decisions. 

For more information on the budgeting process and how to create value for your organization, reach out to your BKD Trusted Advisor or use the Contact Us form below.