With the sound of a standing refrain, clinical laboratories continue to face pressure from reduced reimbursement and the persistent need to manage (ie, reduce) costs. Although many laboratory directors come from a technical background, effective laboratory management requires knowledge that extends beyond the technical aspects of running a laboratory and must include an understanding of nuanced financial management to be successful. In this case, financial management includes financial accounting (reporting) for stakeholders, managerial accounting to support decision making, and revenue and expense management to ensure operational stability.1 When the clinical laboratory is within a hospital, financial management can be further complicated by shared revenue streams and intermingled cost structures. Thus, we lay the focus of this article in that location.
Define Business and Revenue Streams
The first step in gaining a full understanding of the lab’s financial picture is to gain an understanding of the various customers served (including inpatients) and how the laboratory gets paid (including outreach revenue). A hospital laboratory generally serves four patient segments with each segment being paid differently and presenting varying associated costs. The segments are:
NOTE: Any of patient segments 2, 3, or 4 may be served by a hospital-based outreach program.
Once your laboratory’s business segments are clear, it is then necessary to gain an understanding of how and how much the laboratory is paid for serving each segment. Laboratory testing is frequently paid along with other clinical services and it may be difficult to parse out laboratory-specific revenues. Nonetheless, doing so is a worthy endeavor, given that if laboratory revenue is not recognized or demonstrated, the laboratory may be viewed as a cost center and lab leadership will be challenged in justifying the acquisition of new resources.
Overall laboratory financial contribution should be analyzed for each of the four different patient segments. It is expected that the inpatient segment will not be profitable, but by expanding laboratory services beyond this population, the laboratory is more likely to have a positive bottom line, providing additional income to support the organization overall.
Most laboratories are able to estimate gross revenue; however, this tends to be a highly inaccurate measurement of true payment for laboratory testing. Gross revenue is the amount charged, net revenue is the amount received, and many hospitals find it easiest to apply a contractual allowance to estimate net revenue. While it is not perfect, a contractual adjustment of charges is more accurate than using gross charge data alone.
Laboratory testing is reimbursed by payors in two ways: bundled or fee-for-service. Unless the laboratory uses a discrete billing process, it is very difficult to discern true net revenue. For bundled payments, laboratory testing is paid along with all other services performed for that patient episode or diagnosis and is not separately recognized. Further, most laboratories do not attempt to quantify revenue from bundled payments. That said, it is possible to identify collected revenue for fee-for-service reimbursements by accessing the electronic Remittance Advice statement sent for each insurance claim, although this can be labor intensive.
Recent changes to the Protecting Access to Medicare Act of 2014 (PAMA) requires hospitals to report net revenue for outreach program patients.2 Hospital laboratories must gather discrete data and report net revenue paid by non-governmental third-party payors, for each procedure (CPT code). Once a hospital laboratory has established this process of identifying net revenue, it will be easier to routinely monitor actual net revenues in the future.
Clearly Identify Costs
In addition to understanding revenue, it is necessary to accurately identify all costs in the laboratory in order to gain the full financial picture (see TABLE 1 for general terms and definitions). There are four types of costs in the lab: variable, fixed, direct, and indirect:
As test volumes increase, variable costs will definitely increase, and direct costs may increase if staff is already working at capacity; however, indirect and fixed costs will not increase. The COVID-19 pandemic notwithstanding, many hospital laboratories have excess capacity and are able to bring on additional test volumes without hiring additional staff and substantially increasing costs. This generally represents the financial value of a laboratory outreach program—utilizing existing laboratory capacity and subsequently lowering costs, while also generating revenue. Given the substantial pressure to seize financial control in health care operations, any initiative that reduces unit costs and generates profitable revenue tends to be welcomed.
Once the laboratory has an accurate accounting of costs and revenues, demonstrating profit or loss becomes straightforward. To remain competitive, it is increasingly necessary to demonstrate an accurate bottom line, as financial contribution can be an important part of demonstrating overall laboratory value and is particularly valuable when pitching for new instrument or device acquisitions or other forms of testing expansion. A laboratory also can demonstrate a return on investment (ROI) for a specific initiative, department, or capital expenditure, calculating the timeframe wherein the laboratory will realize a profit following the initial cost outlay. Examples of such initiatives include:
In order to build an accurate ROI model, the laboratory must be able to quantify initial costs, ongoing costs, subsequent revenues (or savings), and growth projections over a period of time. For example, the ROI calculation to develop a new toxicology department is obviously more complex than simply justifying the installation of an auto-verification module for the LIS. See the SIDEBAR for an example of creating an ROI for acquiring a new serology analyzer and its attendant workflow.
Expand and Increase Laboratory Value
Transparent and effective financial control in the laboratory can be an extremely powerful tool, not only for the health of the laboratory operation, but for elevating the overall role and value of the laboratory within the organization. Certainly, hospital administrators are focused on managing costs and increasing profitable revenue streams; however, they are also focusing on new strategies to support long-term growth and success. These strategies include increasing primary care access and alignment, expanding ambulatory services, improving patient care by minimizing clinical variation, and preparing for managing population health.3 A laboratory that is financially efficient and effective is well-poised to contribute to the organization’s future success.
Jane M. Hermansen, MBA, MT(ASCP), is Manager of Outreach and Network Development at Mayo Clinic Laboratories in Rochester, Minnesota. She received a BA in medical technology from Concordia College in Moorhead, Minnesota, and an MBA from the New York Institute of Technology. Jane’s 25+ years of clinical laboratory experience spans clinical research; process engineering; project management; and laboratory outreach consulting, training, and facilitation.
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