The ABCs of activity-based costing

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This Business Solutions episode of the Insights podcast features Tom Thornton, practice director at Net at Work.

Net at Work, a technology advisor to healthcare organizations, recently published a white paper with MGMA called, “Activity-Based Costing’s Time Has Come,”  and in this episode, Thornton describes the many benefits of activity-based costing.

Also, you can follow this link to begin a complimentary business health assessment courtesy of Net at Work’s team of experts.

Editor’s note: The following Q&A has been edited for length and clarity.

Q: Net at Work provides something called ABC. Can you break that down for us?

A: ABC, or activity-based costing, is basically a way of figuring out the cost of services based on the activities needed to produce them. It's like looking under the hood of a car to see what parts are needed to make it work. In healthcare, ABC can help better understand the cost of providing care by breaking down the different activities involved in allocating related costs accordingly.

For example, let’s say a practice wants to know how much it costs to provide care for a patient who has undergone surgery. ABC would involve identifying all the activities involved, such as pre-operative consultations, operating room setup, nursing and physician care, anesthesia, medications, and post-operative follow-up care. The costs associated with each portion of the surgical care would then be allocated to the patient’s total cost based on how much of each activity or resource was needed.

This type of analysis can provide a more accurate picture of the cost of providing care and can help healthcare organizations make more informed decisions about resource allocation, pricing and cost control.

Q: Can you talk about how ABC is different than traditional cost accounting?

A: I look at it like this. Traditional cost accounting is like taking a broad brush to figure out how much a product or service costs. It looks at the overall cost of producing something and divides that by the number of products produced. It’s a bit like averaging the cost out over everything.

ABC, on the other hand, is more like taking a magnifying glass to the costs involved. Instead of just looking at the overall cost, it breaks the costs down into smaller activities, such as the time and resources needed for each step in the process. This helps provide a more detailed and accurate understanding of the costs associated with each activity.

In healthcare, traditional cost accounting may only consider direct costs such as labor and supplies and may allocate indirect costs based on a few broad cost drivers, like the number of patient visits. ABC, however, looks at the individual activities involved in providing care, such as diagnostic testing, medications, and nursing care, and allocates costs based on the resources used for each activity.
 
Q: What are some of the other benefits that you’re seeing in practices that adopt ABC?
 
A: Great question. Obviously, when an organization is able to understand the cost of providing treatment on a more granular level it allows them to use this information to make more informed decisions about the care they’re providing.

For instance, ABC enables healthcare organizations to identify the resources that are being underutilized or overutilized and adjust resource allocation accordingly, leading to better resource utilization and improved cost control.

This in turn can lead to increased efficiency, as well. If you’re able to identify that certain resources, or even staff for that matter, are only needed for a handful of procedures, then you can adjust your scheduling so that you are able to maximize the time and activities related to those procedures.

Of course, the overarching goal of ABC is to help healthcare organizations enhance the quality of care that they are providing to their patients. Once practices are able to better understand their costs more accurately, they can focus on enhancing the quality of care and improving patient outcomes, rather than just controlling costs. This is why we’ve seen such an emphasis placed on the value-based care model in the last several years, but that’s a much larger conversation that we’ll save for a later time.

Q: Can you talk about the role technology plays in implementing ABC?

A: Technology plays a critical role in implementing ABC in healthcare by providing the tools and systems needed to collect, process, and analyze the data required for cost allocation. One key component in helping healthcare organizations move toward adopting the ABC method is a Digital Operations Platform.

Now, Digital Operations Platform is a relatively new term that describes the evolution of traditional accounting and Enterprise Resource Planning systems to the Next Generation ERP technology that is designed to meet the needs of healthcare organizations both today and in the future. These cloud-native solutions are driven by Artificial Intelligence (AI) and Machine Learning (ML) to drive efficiency and innovation while extending the ERP ecosystem to patients, payers, suppliers and other stakeholders.

A healthcare DOP can be used to create cost models that incorporate the multiple cost drivers used in ABC to allow healthcare offices, clinics and senior living organizations to estimate the costs more accurately even as the costs of supplies and labor fluctuate.

And one of the most beneficial features of a healthcare DOP is the ability to automate many of the manual processes using enhanced workflows. This helps reduce the time and effort required in data collection, cost allocation and reporting just to name a few.

Q: What do you think the future has in store for ABC?

A: I think the future of ABC in healthcare looks very promising. As healthcare organizations continue to face increasing cost pressures and the need to deliver high-quality care to patients, the use of ABC is likely to become even more widespread.

We’ve already seen significant enhancements when it comes to new technologies integrating with electronic health records and other systems that are already in use today. These integrations will continue to improve over time and provide even greater enhancements when it comes to things like predictive modeling, real-time analysis, and process automation.

Another potential direction is the use of ABC to support the value-based care initiative, as I mentioned earlier. Since healthcare organizations are paid based on the quality of care they provide, rather than the volume of services delivered, organizations will be increasingly looking for ways to reduce costs without sacrificing quality.

Finally, ABC may also play a role in supporting new payment models, such as bundled payments or shared savings arrangements. We know that in these models, healthcare organizations are given a fixed budget to provide care for a specific group of patients, like dialysis, for example. ABC can help these organizations to control the costs associated with these procedures to help ensure a solid and more predictable bottom line.

Learn more about Net at Work and Activity-Based Costing:

• Client Success Story: Hawaii Dental Service
• Client Success Story: Children First
• ERP for Healthcare
• Benefits of Cloud-Based Nonprofit Accounting Software

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