Overhead Cost Analysis

  • Do you know how to calculate your cost per unit of work?
  • Once you can arrive at this figure, you have a key tool for determining if your overhead costs are in line with the amount of work needed to get there. What Makes Up Overhead Costs?

Unfortunately, many practices evaluate overhead in different ways, making it difficult to use the information effectively to benchmark against other performances. There are two preferred approaches:

1) As a percentage of revenue
2) As a cost per unit of service (cost per RBRVS RVU)

This month’s bulletin will review both methods; but first, there are some considerations required to refine your cost data.

Lines of Business
You should consider the businesses involved in your practice. First, there is the med/surg business‹the diagnosis and management of eye diseases. You may also be providing refractive surgery. This should be considered as a separate business, as should your optical dispensary, if you have one.

Remember to separate the costs and the revenue for each line of business. Apportion your overhead costs among the separate businesses (remember that this cost apportionment is for analysis purposes‹there may be no advantage in actually legally separating the lines of business).

Refining the Cost Data

Profit
The business success of the practice is measured in profit and loss.

Traditionally, physicians who own their practice receive revenue, pay expenses, and take home the balance. The problem with this method is that the practice cannot be viewed as a business distinct from the physician-owners. The physician should wear two hats‹one as a business owner and one as a “unit of production” (an employee of the practice). The physician-owner(s) should assign a “physician cost” line item. That cost should reflect the salary and benefits that would be required to replace the physician-owner(s) with employed physician(s) of comparable skills and experience.

These physician costs are added to the overhead costs, and the sum is compared to the practice revenue. Any surplus after the cost total is subtracted from revenue is considered profit, and any deficit is considered loss. Of course, these calculations will not necessarily affect the dollars the physician-owners take from the practice. These calculations are for performance measurement; they are not the basis for physician compensation.

These revised costs and profit and loss calculations are used to evaluate the performance of the practice as well as to determine the cost-per-RVU calculations.

Expense by Categories
For purposes of this bulletin, we are analyzing practice expenses‹by category and as a percentage of revenue‹by comparing each category to MGMA-provided norms.

A word of caution, however. MGMA data stratifies the responses from practices by practice size in one table and by specialty in another table. Unfortunately, there are insufficient responses to stratify by specialty and practice size in the same table. Consequently, ophthalmology practice data is reported by subspecialty, but not by practice size. The cost structure of a solo ophthalmology practice is very different from a five-physician ophthalmology group. There are economies of scale that are unavailable to a solo practice. If you are in a solo practice, recognize that your costs‹both by category and overall, as a percentage of revenue‹will probably be higher than the norm. A more important criterion for your solo practice will be if your expenses (as a percentage of revenue) change over time.

Percentage of Revenue
This method measures the practice’s overhead expense as a percentage of collected revenue. These percentages vary with the specialty of the practice. For instance, neurosurgeons or anesthesiologists have relatively low office expense, since most of their work is done in the hospital. A neurosurgeon’s office rent expense, as a percentage of his or her revenues, is compared to national averages for neurosurgeons. Ditto for other expense categories, such as staff salaries, office equipment, medical equipment, etc.

Focusing on ophthalmology practices, most pediatric ophthalmology practices will have a higher overhead cost than refractive surgery practices, since most refractive work is done outside the office; and therefore, less office overhead expense is required.

For the sample ophthalmology practice that we reviewed, the total overhead expense was $1,170,318. This represents 46.5% of the practice revenue.

 

Total Practice Revenue

$2,516,812

Practice X $

Practice X % of Revenue

MGMA Median**

Employee Expense

$565,024

22.45%

27.16%

Office Occupancy

$150,505

5.98%

6.60%

Furniture & Equipment

$28,943

1.15%

3.12%

Medical Supplies

$44,296

1.76%

1.49%

Office Supplies

$69,464

2.76%

2.17%

Professional Liability Insurance

$33,222

1.32%

0.98%

Other Insurance

$3,524

0.14%

0.29%

Outside Professional Services

$89,347

3.55%

1.05%

Promotion & Marketing

$6,292

0.25%

1.33%

Business, Property, and other taxes

$11,326

0.45%

0.32%

Information Systems

$58,893

2.34%

1.45%

Other Operating Cost

$109,481

4.35%

5.90%

TOTAL EXPENSE

$1,170,318

46.50%

51.86%

 

** These MGMA numbers are several years old. For current numbers contact the MGMA for their latest “Cost Survey” reports.

How Can This Be Interpreted?
In analyzing this table, you can see, for instance, that the practice’s employee cost is 22.45% of revenue vs. the MGMA median of 27.16%. The interpretation should always begin with what you know about your own practice. Are you understaffed? Do you have employees that are not being paid at market rates (either underpaid staff or perhaps physician family members working unpaid in the office)?

Similarly, the office occupancy cost is below the MGMA median. Does the practice, or do its physicians, own the building? If so, is the entity that owns the building charging market-rate rental to the practice?

Remember, costs that are too low may be costing the practice through reduced revenue. Insufficient office space and too few staff may be crimping the office’s efficiency and reducing the number of patients the practice can see.

Ron Rosenberg, PA, MPH, Author Practice Management Resource Group San Rafael, California
Irene Chriss, Editor Director, AAO Practice Management Department